ASIAN DEVELOPMENT BANK Operations Evaluation Department

PROGRAM PERFORMANCE EVALUATION REPORT

FOR

PAKISTAN

In this electronic file, the report is followed by the Management response.

Performance Evaluation Report

PPE: PAK 31108

Capital Market Development Program

(Loans 1576-PAK and 1577-PAK[SF])

in Pakistan

October 2005

Operations Evaluation Department Asian Development Bank

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

At Appraisal At Program Completion At Operations Evaluation (September 1997) (October 2001) (April 2005) PRe1.00 = $0.0246 $0.0161 $0.0168 $1.00 = PRs40.62 PRs62.00 PRs59.52

ABBREVIATIONS

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

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

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

Operations Evaluation Department, PE-667

CONTENTS Page

BASIC DATA iii EXECUTIVE SUMMARY iv

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

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

III. ACHIEVEMENT OF PROGRAM PURPOSE 11 A. Performance Indicators 11 B. Program Outcomes 13 C. Sustainability 15 D. Technical Assistance Loan 16

IV. ACHIEVEMENT OF OTHER DEVELOPMENT IMPACTS 16 A. Organizational Impact 16 B. Socioeconomic Impact 16

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

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

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

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

APPENDIXES

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

Attachment: Management Response

BASIC DATA

Program Preparation/Institution Building TA Technical Assistance Name Type Person- Amount Approval No. Months ($’000) Date 2393 Capital Market Development ADTA 23.0 865 7 Sep 1995 2812 Interest Rate Management of National Savings ADTA 9.5 100 18 Jun 1997 Scheme 2825 Capital Market and Insurance Law Reform ADTA 4.0 100 14 Jul 1997 2865 Restructuring of Public Sector Mutual Funds ADTA 32.0 800 15 Sep 1997 2866 Reform of the Insurance Industry ADTA 40.0 700 15 Sep 1997 2867 Reform of Pension and Provident Funds ADTA 34.0 600 15 Sep 1997

Key Project Data ($ million) As per ADB Documents Actual Loan 1576-PAK TA Loan Loan 1576-PAK TA Loan 1577-PAK(SF) 1577-PAK(SF) ADB Loan Amount/Utilization 250.0 5.0 250.0 3.6a

Key Dates Expected Actual Loan 1576-PAK TA Loan 1577-PAK(SF) Fact-Finding 4–18 Apr 1997 3–16 Apr 1997 Appraisal 8–28 Jul 1997 Loan Negotiations 2nd week, Sep 1997 16–18 Sep 1997 Board Approval 1st week, Nov 1997 6 Nov 1997 Loan Agreement 5 Jan 1998 5 Jan 1998 Loan Effectiveness 5 Apr 1998 5 Jan 1998 First Disbursement 5 Apr 1998b 6 Jan 1998 27 Apr 1999 Second Disbursement 6 Jan 2000b 22 Jun 2000 Loan Closing 31 Dec 2000 31 Oct 2001c 30 Jul 2002 Months (effectiveness to completion) 33 46 55

Borrower Pakistan Executing Agency Ministry of Finance

Mission Data Loan 1576-PAK TA Loan 1577-PAK(SF) No. of Missions Person-Days No. of Missions Person-Days Reconnaissance 1 52 Fact-Finding 1 70 Appraisal 1d 126 Project Administration Contact Negotiations 1 37 Inception 1 126 Review 6 d 179 1 15 Program Completione Operations Evaluation 1d 48

ADTA = advisory technical assistance. a The remaining $1.2 million was canceled at loan closing. The amounts used and canceled do not add to $5 million because of fluctuation in the $/SDR exchange rate. b For Loan 1576-PAK. c To complete program implementation, the loan closing date was extended twice. d For Loan 1576-PAK and TA Loan 1577-PAK(SF). e The program completion report was prepared with no program completion mission.

EXECUTIVE SUMMARY

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

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

In conjunction with the CMDP, ADB approved a technical assistance (TA) loan of $5 million equivalent from ADB Special Fund resources for the Capacity Enhancement of the Securities Market (TA Loan 1577-PAK[SF]). The TA loan aimed to support the (i) institutional strengthening of the Securities and Exchange Commission of Pakistan (SECP), (ii) strengthening of the self-regulatory mechanism for key market participants, (iii) establishment of the National Clearing and Settlement System (NCSS), and (iv) establishment of an over-the-counter (OTC) market to develop the secondary bond market.

The CMDP loan took effect on 5 January 1998. The first tranche of $125 million was disbursed on 6 January 1998. The second tranche of the same amount was disbursed on 22 June 2000, 6 months later than originally scheduled, because of slow program implementation. At the release of the second tranche, ADB confirmed compliance with eight conditions for the release, substantial compliance with one condition, and partial compliance with two conditions. To complete the Program, ADB extended the loan closing date to 31 October 2001, 10 months later than first planned. TA Loan 1577-PAK(SF) closed on 30 July 2002, 19 months later than planned. The program completion report (PCR), prepared in November 2002, rated the CMDP successful.

The Operations Evaluation Mission (OEM) confirmed full compliance with 26 out of 30 policy conditions that were to be met before the release of the first tranche. Of the remaining four conditions, one had been partly complied with, one had not been complied with, while compliance with the other two conditions could not be verified. The OEM also confirmed full compliance with 20 out of the 28 conditions to be met by the time the second tranche was released. Of the remaining eight conditions, one had been complied with after major modification. Overall, the OEM found that 46 (79%) of the 58 conditions had been fully complied with. The PCR did not assess the status of CMDP conditions to be met before the release of the first tranche, but confirmed full compliance with 21 (75%) of the 28 remaining conditions.

In the OEM’s assessment, the CMDP was highly relevant. The assessment was based on the following observations: (i) the key implementing agency, i.e., SECP (the Corporate Law Authority [CLA] at the time of loan approval), had taken ownership of the reforms and was supported by a favorable political economy of decision making; (ii) ADB processing missions had adequate knowledge and analysis of the country; (iii) ADB missions had extensive policy dialogue with the agencies concerned and broad consultation with stakeholders, (iv) the v program purpose was consistent with the country’s development priorities and the ADB country and sector assistance strategy at appraisal and evaluation; (v) the lending modality, i.e., program loan, was appropriate, given the reform momentum and foreign reserves of the country; and (vi) the policy matrix was comprehensive, cohesive, and realistic, and it had a manageable number of appropriately sequenced program measures.

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

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

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

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

On the basis of the above, the overall rating of the CMDP is successful.

The lack of verifiable records from the implementing agencies and ADB hampered the evaluation of TA Loan 1577-PAK(SF). From the limited data available, the OEM considered that TA outputs: (i) contributed marginally to the institutional strengthening of the SECP and the privatization of mutual funds, (ii) contributed significantly to the establishment of NCSS, and (iii) did not lead to the promotion of self-regulatory organizations and an OTC debt market. Overall, the TA loan contributed less than expected to the CMDP and is therefore rated partly successful.

The OEM attributed the success of the CMDP to SECP’s ownership of reforms, supported by a favorable political economy and effective policy dialogues. The key ingredients of the effective dialogues were the following: (i) ADB processing missions knew enough about the country because an economic and sector work mission had been fielded before the reconnaissance mission; (ii) the reconnaissance mission had extensive policy dialogue with agencies concerned, especially CLA, and broad consultation with stakeholders; (iii) the policy matrix was drafted at an early stage of processing, and the Government took substantial actions before loan approval; (iv) ADB processing and review missions made efforts to come up with alternative policy measures leading to realistic solutions while enhancing ownership of reforms; (v) one ADB processing mission member remained responsible for program implementation until the end, contributing to a close and constructive partnership; and (vi) ADB continued to monitor unattained non-tranche program measures by extending the loan closing date. All these are considered good practices for ADB’s policy-based lending.

The establishment of workable self-regulatory market institutions was one of the few unfulfilled items on the CMDP agenda. SECP believes that excessive autonomy granted to regional, mutualized stock exchanges may create self-interest clubs, and is therefore actively pursuing demutualization before the exchanges’ self-regulation replaces some of the SECP’s regulatory oversight. This approach could apply as well to other developing countries pursuing capital market governance reforms in some cases, depending on the ownership and management structure of their stock exchanges.

Delays in the implementation of related stand-alone TAs and TA Loan 1577-PAK(SF) impeded timely compliance with the relevant conditions for the second tranche under CMDP. This experience underscores the need for realistic and consistent timelines.

Presumably because of the lack of verifiable outputs and records, no overall rating was given to TA Loan 1577-PAK(SF) in the PCR on CMDP. No separate project completion report was prepared for this TA loan. The OEM’s review of the relevant project/program completion reports suggested a general weakness in ADB’s self-evaluation of TA loans attached to project or program loans.

Bruce Murray Director General Operations Evaluation Department

I. BACKGROUND

A. Rationale

1. In the early 1990s, the economy of Pakistan grew modestly but was characterized by balance of payment and fiscal imbalances that undermined economic stability. From 1993 to 1996, the Government made several attempts under International Monetary Fund (IMF) programs to address the macroeconomic imbalances and deep-rooted structural problems. However, slippages in policy implementation as well as policy reversals muted the supply response, bringing the economy to the verge of a banking crisis in 1996. The economic instability and institutional constraints of the capital market induced vulnerability in the Karachi Stock Exchange (KSE) Index, which fell from around 2660 in March 1994 to 1332 on 10 September 1996.

2. Citing economic mismanagement and corruption, the President of Pakistan dismissed former Prime Minister Benazir Bhutto’s administration in November 1996, dissolved parliament, and called for elections. In February 1997, the Pakistan Muslim League, headed by former Prime Minister Nawaz Sharif, won a landslide victory at the polls and captured a majority of the seats in parliament. With a strong electoral mandate, the new Government quickly prepared a comprehensive stabilization and structural adjustment program, including banking and capital market reforms. In line with its country operational strategy for Pakistan of 1995,1 the Asian Development Bank (ADB) was to support the capital market reform. This support was premised on IMF and World Bank support for banking sector reform.2

3. The report and recommendation of the President (RRP) gave the following rationale for the Capital Market Development Program (CMDP):3 “The development of the securities market will facilitate the efficient allocation of resources in the economy and help broaden and deepen the financial sector, while providing alternative sources of funding to industry, which has traditionally relied on Government directed credit.”

B. Formulation

4. In early 1997, the Government requested ADB to process the CMDP. Diagnostic studies for the CMDP relied on the findings of an economic and sector work mission from December 1996 to January 1997, supplemented by outputs of a preceding technical assistance (TA) grant. 4 Following extensive policy dialogue with relevant Government agencies and broad consultation with market participants, a reconnaissance mission in February–March 1997 determined the CMDP objective and components. A fact-finding mission in April 1997 reached broad consensus with the Government on the policy matrix, which included more than 40 actions to be taken before the release of the first tranche. Substantial progress was made on the prior actions. An appraisal mission was therefore fielded in July 1997 to fine-tune the policy matrix and discuss the scope of a TA loan to complement the CMDP. An ADB mission visited Washington, DC, in August 1997 to coordinate with the IMF and the World Bank on policy

1 ADB. 1995. Country Operational Strategy Study for Pakistan. Manila. 2 International Monetary Fund. 1997. Enhanced Structural Adjustment Facility; and World Bank. 1997. Banking Sector Adjustment Loan. 3 ADB. 1997. Report and Recommendation of the President to the Board of Directors on Proposed Loans to the Islamic Republic of Pakistan for the Capital Market Development Program. Manila (Loan 1576-PAK, for $250 million and TA Loan 1577-PAK[SF], for $5 million, approved on 6 November 1997). 4 ADB. 1995. Technical Assistance to the Islamic Republic of Pakistan for Capital Market Development. Manila (TA 2393-PAK, for $865,000, approved on 7 September 1995). 2 support operations in Pakistan. The loan negotiation for the CMDP was held in September 1997.

C. Purpose and Outputs

5. The purpose of the CMDP, as stated in the RRP, was “to accelerate the mobilization of long-term resources and improve the efficiency of its allocation through a diversified and competitive capital market, which encourages broad-based participation of issuers and investors.”5 The CMDP had seven components: (i) creating an enabling policy environment to enhance competition and a level playing field, (ii) strengthening securities market governance, institutions, regulation, and supervision; (iii) improving and modernizing the market infrastructure and promoting its integration; (iv) developing the corporate debt market; (v) reforming the mutual fund industry; (vi) developing the leasing industry; and (vii) promoting contractual savings through reforms of the insurance sector and pension and provident funds. The CMDP comprised a total of 58 policy actions (Appendix 1)—30 actions already taken before Board approval, and 28 actions to be taken by the time the second tranche was released (11 were conditions for the release).

6. TA Loan 1577-PAK(SF) for Capacity Enhancement of the Securities Market was to support the (i) institutional strengthening of the Securities Exchange Commission of Pakistan (SECP), (ii) strengthening of the self-regulatory mechanism for key market participants, (iii) establishment of the National Clearing and Settlement System (NCSS), and (iv) establishment of an over-the-counter (OTC) market to develop the secondary bond market (Appendix 2).

D. Cost, Financing, and Executing Arrangements

7. On 6 November 1997, ADB approved a loan of $250 million from its ordinary capital resources for the CMDP. Counterpart funds generated from this program loan were to be used by the Government to finance the adjustment costs of around $514 million associated with the CMDP and high-priority development projects (para. 36).

8. The CMDP was to be implemented over a period of 3 years from the date of loan effectiveness. The loan was to be disbursed in two equal tranches of $125 million each, the first to be available upon loan effectiveness and the second after 2 years, as indicated in the policy matrix and the main text of the RRP. However, the program summary in the RRP indicated that the second tranche could be released within the 3-year program period. The Loan Agreement stipulated that “the proceeds of the Loan are expected to be utilized by 31 December 1999” while indicating the loan closing date to be 31 December 2000. The reason for this one-year discrepancy was not discussed.

9. The Ministry of Finance (MOF) was the Executing Agency for the program loan. It was to coordinate and monitor the overall implementation of the CMDP, and administer the utilization of the loan proceeds. MOF was to be supported by (i) SECP in overseeing and coordinating the implementation of the reforms in the stock exchanges, leasing industry, and mutual funds; and (ii) the Ministry of Commerce (MOC) in overseeing the implementation of the insurance industry reforms.

5 The Loan Agreement stated that the CMDP objective is “to develop the Borrower’s capital market by enhancing investor confidence and promoting a diversified, competitive and market-based capital market through, among other things, appropriate regulatory and institutional reform.” 3

10. TA Loan 1577-PAK(SF) (footnote 3) for $5 million was approved in conjunction with the CMDP. SECP was the Executing Agency for the TA loan. The Central Depository Company of Pakistan (CDC) was to provide support in implementing the NCSS component, while a separate legal entity, with the support of the stock exchanges and lead financial institutions, was to be set up for the establishment of an OTC market.

11. To complement the CMDP, ADB also approved the following stand-alone TAs in June– September 1997: (i) TA 2812-PAK: Interest Rate Management of National Saving Scheme,6 (ii) TA 2825-PAK: Capital Market and Insurance Law Reform,7 (iii) TA 2865-PAK: Restructuring of Public Sector Mutual Funds, 8 (iv) TA 2866-PAK: Reform of Insurance Industry, 9 and (v) TA2867-PAK: Reform of Pension and Provident Funds.10

E. Completion and Self-Evaluation

12. The CMDP loan took effect on 5 January 1998.The first tranche of $125 million was disbursed on 6 January 1998. The second tranche of the same amount was disbursed on 22 June 2000, 6 months later than originally scheduled. To allow monitoring of the progress of unaccomplished program measures, the loan closing date of Loan 1576-PAK was extended twice to 31 October 2001, 10 months later than initially planned (para. 40). TA Loan 1577- PAK(SF) closed on 30 July 2002, after four extensions and 19 months later than initially planned. The program completion report (PCR)11 on both the CMDP and the TA loan was circulated to the Board in November 2002.

13. The PCR rated the CMDP successful on the basis of the following: (i) the Program was highly relevant to the country and maintained its relevance during implementation; (ii) the Program achieved definite results in key reform areas, e.g., modernization of the stock market infrastructure, establishment of SECP, and improved efficiency and enhanced accountability of the stock market; and (iii) CMDP outputs and outcomes were likely to be sustained. The PCR confirmed full compliance with 51 policy requirements, substantial compliance with 2 requirements, 12 and partial compliance with 3 requirements, 13 while considering 2 other requirements14 inappropriate, in accordance with the opinion expressed by the consultant under TA Loan 1577-PAK(SF). The PCR recommended independently evaluating the CMDP within 3 years.

6 ADB. Technical Assistance to Pakistan for Interest Rate Management of National Saving Scheme. Manila (TA 2812-PAK, for $100,000, approved on 18 June 1997). 7 ADB. Technical Assistance to Pakistan for Capital Market and Insurance Law Reform. Manila (TA 2825-PAK, for $100,000, approved on 14 July 1997). 8 ADB. Technical Assistance to the Islamic Republic of Pakistan for Restructuring of Public Sector Mutual Funds. Manila (TA 2865-PAK, for $800,000, approved on15 September 1997). 9 ADB. Technical Assistance to the Islamic Republic of Pakistan for Reform of Insurance Industry. Manila (TA 2866- PAK, for $700,000, approved on 15 September 1997). 10 ADB. Technical Assistance to the Islamic Republic of Pakistan for Reform of Pension and Provident Funds. Manila (TA 2867-PAK, for $600,000, approved on 15 September 1997). 11 ADB. 2002. Program Completion Report on the Capital Market Development Program (Loan 1576-PAK) and Capacity Enhancement of the Securities Market (TA Loan 1577-PAK[SF]) in Pakistan. Manila. 12 These concerned (i) upgrading of corporate legislation (second-tranche condition), and (ii) improvement of credit administration in the leasing industry (non-tranche condition). 13 These concerned (i) establishment of NCSS (second-tranche condition), (ii) restructuring of mutual funds run by state-owned investment companies (second-tranche condition), and (iii) upgrading of the Pakistan Insurance Institute (non-tranche condition). 14 These concerned (i) development of the Mutual Fund Association of Pakistan and Leasing Association of Pakistan as self-regulatory organizations, and (ii) establishment of an OTC market for government and corporate debts. 4

14. The PCR adequately assessed the CMDP outputs and outcomes. However, it did not discuss compliance with the conditions for the second tranche at the time of its actual release15 and the appropriateness of ADB’s disbursement decision. Moreover, the PCR did not include enough information to allow an evaluation of TA Loan 1577-PAK(SF) and, hence, did not give an overall rating (para. 84). The PCR’s findings on the TA loan can be summarized as follows: (i) two components, i.e., institutional strengthening of SECP and establishment of the NCSS, complemented CMDP; (ii) program measures related to two other components, i.e., strengthening of the self-regulatory framework and establishment of an OTC market for the secondary bond market, were premature; and (iii) another component added in January 2000 to support the restructuring of mutual funds run by state-owned companies complemented CMDP.

F. Operations Evaluation

15. An Operations Evaluation Mission (OEM) was undertaken from 25 April to 10 May 2005. The OEM met with representatives of the following: MOF, MOC, State Bank of Pakistan (SBP), SECP, Privatization Commission, Central Directorate of National Savings (CDNS), KSE, Lahore Stock Exchange (LSE), Islamabad Stock Exchange (ISE), CDC, National Clearing Company of Pakistan (NCC), Leasing Association of Pakistan (LAP), and other agencies concerned and market participants.16 This program performance evaluation report (PPER) incorporates OEM findings, survey results, observations of ADB staff concerned, and a review of reports and documents related to the CMDP. The draft PPER was circulated to the Government and within ADB. Comments received were considered in finalizing the PPER.

16. This report also considers the earlier evaluation of related TAs,17 which rated TA 2812- PAK (footnote 6) highly successful; TA 2825-PAK (footnote 7) and TA 2866-PAK (footnote 9) successful; and TA2865-PAK (footnote 8) and TA2867-PAK (footnote 10) partly successful.

II. PLANNING AND IMPLEMENTATION PERFORMANCE

A. Formulation and Design

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

15 ADB. 2000. Capital Market Development Program Progress Report: Release of Second Tranche. Manila. In this report, ADB confirmed compliance with eight conditions, substantial compliance with one, and partial compliance with two. 16 Before the OEM, the domestic consultant surveyed the outcomes of the CMDP through semi-structured interviews with five reputed market players. OEM conducted interviews on the basis of the survey findings. 17 ADB. 2003. Technical Assistance Performance Audit Report (TPAR) on Selected Advisory Technical Assistance for Capital Market Development in Pakistan. Manila. 18 The key policy actions included (i) reforms of taxes on equity transactions, (ii) relaxation of investment guidelines for institutional investors, (iii) promulgation of SECP Act 1997, (iii) reforms of governance in stock exchanges, (iv) introduction of an automated share trading system, and (v) promulgation of the Central Depository Act 1997. 5

efforts to come up with alternative policy measures19 leading to realistic solutions to bottleneck issues faced by the country and its institutions. The OEM also noted that ADB had identified the need for a full-fledged Program through the less-than-satisfactory Financial Sector Intermediation Loan,20 which was hybrid in nature, addressing the need for investment financing and policy reforms.

18. The OEM assessed the CMDP design as appropriate for the following reasons: (i) the program objective was consistent with the country’s development priorities and ADB’s country and sector assistance strategy, both at appraisal and at evaluation; (ii) the lending modality, i.e., program loan, was appropriate in view of the reform momentum and foreign reserves of the country;21 (iii) the policy matrix was comprehensive, cohesive, and realistic, and consisted of a manageable number of appropriately sequenced program measures; (iv) the program framework identified workable performance indicators; (v) risk-mitigating measures based on adequate risk analysis were in place; (vi) the TA loan and grants provided were enough to support CMDP implementation; and (vii) CMDP was designed to complement the IMF’s Enhanced Structural Adjustment Facility (ESAF) and the World Bank’s Banking Sector Adjustment Loan.

19. The OEM largely supported the policy matrix, with some reservations on two policy measures: (i) self-regulation of market participants, and (ii) development of the corporate debt market. For the first item, the program measure for the release of the second tranche required the SECP to set minimum criteria for granting a SRO status to stock exchanges. However, the SECP Act 1997 already assumes stock exchanges to be SROs under the oversight of SECP. Hence, the policy matrix should have specified the criteria that stock exchanges had to follow to maintain the SRO status. With such guidance, the SECP could have put more effort into pursuing this particular program measure. Another program measure related to the SRO status for the Mutual Fund Association of Pakistan (MUFAP) would have been meaningful only after the Government divested itself of its majority shareholding in the mutual fund industry. As to the corporate debt market, CMDP included the following measure: “market participants will develop and establish an OTC market.” This should have been a program outcome rather than a program measure. The policy matrix should have specified who should do what to achieve the expected outcome.

20. TA Loan 1577-PAK(SF) was designed to support the agencies concerned in meeting the CMDP conditions for the second tranche that were not supported under previous stand-alone TAs. Unlike the CMDP, the TA loan did not have a clear scope until the last phase of CMDP formulation, and the RRP did not spell out the terms of reference in detail.

19 For instance, a regulatory architecture envisaged at the start called for SECP to provide off-site supervision while the proposed National Self-Regulatory Association (NSRA) provided on-site and continuous surveillance. At the same time, however, ADB and CLA agreed to promote self-regulatory organization as an alternative to the creation of the NSRA. The Government pursued this alternative. Likewise, ADB was open to two policy options: (i) SECP overseeing the securities market while creating a separate entity to supervise corporate affairs; or (ii) SECP overseeing both the securities market and corporate affairs. The Government pursued the latter option. 20 ADB. 1995. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the Islamic Republic of Pakistan for the Financial Sector Intermediation Loan. Manila (Loan 1371-PAK, for $100 million, approved on 7 September 1995). 21 In Pakistan, fiscal and external imbalances became unsustainable in 1996, resulting in an unprecedented decline in foreign exchange reserves to the equivalent of 2 weeks of imports in November 1996. 6

B. Achievement of Program Measures

21. The OEM confirmed full compliance with 26 out of 30 policy conditions that were to be met before the release of the first tranche. Of the remaining four conditions, one had been partly complied with, one had not been complied with, while compliance with the other two conditions could not be verified. The policy condition deemed partly complied with concerned the privatization of mutual funds run by the state-owned National Investment Trust Limited (NIT). The condition deemed not complied with concerned SRO status for MUFAP and LAP. The OEM could not independently verify if the program conditions for the OTC debt market and the Pakistan Insurance Institute had been met.

22. The OEM confirmed full compliance with 20 out of 28 conditions for the second tranche. Of the remaining eight conditions, one had been complied with after major modification (para. 34), five had been partly complied with, and two had not been complied with. The policy conditions that were deemed partly complied with concerned (i) development of an OTC debt market, (ii) strengthening of the regulatory framework, and monitoring and inspection of mutual funds, (iii) privatization of NIT’s mutual funds, (iv) reinforcement of lessors’ right of repossession, and (v) reconstitution of the Insurance Claim Settlement Board. The conditions deemed not complied with concerned (i) setting of minimum criteria for SRO status for the stock exchanges, and (ii) granting of SRO status to MUFAP and LAP.

1. Create an Enabling Policy Environment to Enhance Competition and a Level Playing Field

23. This component had several key policy achievements. It (i) relaxed investment restrictions for employee provident funds and life insurance companies, (ii) rationalized tax anomalies in the equity market, (iii) reformed the interest rate and tax structures of the national savings scheme (NSS), 22 and (iv) rationalized the tax regime for mutual funds. Complemented by TA 2812-PAK (footnote 6), CMDP made particularly noteworthy progress in NSS reform. It (i) aligned NSS returns with yields on market-traded Government bonds, and (ii) ended the tax exemption on NSS by applying uniform tax rates to fixed-income securities. As a key non- CMDP measure implemented in conjunction with the above measures, institutional investors were barred from investing in the NSS.

24. Since CMDP implementation, NSS rates have been adjusted every 6 months since July 2002 to align them with yields on market-traded Government bonds. The yield on 10-year defense savings certificates was revised from 14% to 11.6% in July 2002, 10% in January 2003, 8.5% in July 2003, 7.96% in January 2004, and 8.15% in July 2004. CDNS, the institution responsible for managing NSS, is being rationalized under the Financial (Nonbank) Markets and Governance Program (FMGP).23

22 Administered by CDNS of MOF, NSS is a source of nonbank financing for the fiscal deficit. There are various schemes under NSS, but two major ones are 3-year special savings certificates (SSCs) with semiannual interest payments and 10-year defense savings certificates with single payment of profit plus principal at maturity. Aside from being risk-free, NSS investments are on tap, and until March 2000 were also available to institutional investors, which could benefit from higher-than-market returns and the tax-exempt status of the investments. These NSS peculiarities hampered the growth of both the banking system and the capital markets. As of June 2000, total investment in NSS was PRs715 billion, equivalent to about 60% of all deposits in the banking sector. 23 ADB. 2002. Report and Recommendation of the President to the Board of Directors on Proposed Loans and Guarantees to the Islamic Republic of Pakistan for the Financial (Nonbank) Markets and Governance Program. Manila (Loans 1955/1956/1957-PAK, for $260 million, approved on 5 December 2002). 7

2. Strengthen Securities Market Governance, Institutions, Regulations and Supervision

25. The promulgation of the SECP Act in December 1997 and the operationalization of SECP in January 1999 were the key achievements of CMDP. The SECP Act gave operational and financial autonomy to SECP in regulating the securities markets, nonbanking finance companies (NBFCs), and corporate affairs by empowering it to administer the Securities and Exchange Ordinance of 1969, Modaraba Companies (Floatation and Control) Ordinance of 1980, and Companies Ordinance of 1984.

26. As envisaged under CMDP, the three stock exchanges (i) adjusted their board and management structures,24 (ii) promoted the corporatization of member brokers, and (iii) created investor protection funds. SECP issued most of the rules that the stock exchanges were required to adopt under CMDP. These were (i) trade reporting rules including penalties for insider trading, (ii) inspection rules, (iii) licensing standards for traders and agents, (iv) listing requirements and guidelines, and (v) model contractual agreements. SECP has not set minimum criteria for SRO status for the stock exchanges, as envisaged under CMDP (para. 19). SECP directives have been more dominant than self-regulation on stock exchanges in introducing regulatory changes. While CMDP supported SRO status for MUFAP and LAP, there was little progress toward this end. The consulting team under TA Loan 1577-PAK(SF) submitted a report on the framework for self-regulation by the targeted agencies, but the OEM could neither obtain a copy of this report nor verify SECP’s response to it. The SECP, in consultation with the industry, is now trying to decide whether a single SRO will suffice for all NBFCs or a separate SRO is needed for each licensed activity.

27. In recent years, SECP’s Securities Markets Division has strengthened its enforcement function against insider trading and market manipulation. SECP also aims to phase out the decades-old system of carry-over transactions (COTs),25 which permit excessive leveraging, and is encouraging its substitution with margin financing. Another key follow-on measure being pursued by SECP is demutualization26 of the stock exchanges. While all three stock exchanges have in principle agreed on demutualization and submitted their plans to SECP, LSE and ISE have announced their plan to integrate.

24 The number of directors on board of stock exchanges has been reduced from 18 to 10, half of whom (including the managing director) are nonmember directors. Member directors are elected by members of the stock exchanges, while external directors are nominated by SECP from various trade and professional bodies. The chairmen of the exchanges are elected by the board from the elected directors. The operational and administrative activities of the exchanges are managed by the full-time chief executives, whose appointments are subject to the approval of SECP. 25 A COT is essentially financing for leveraged transactions in the form of a repurchase agreement with a few peculiar characteristics. There is a separate market session for COT financing through the same automated trading system used for cash transactions. However, the COT session takes place after the close of trading hours for the regular market. So the borrower first buys a stock in the regular market and then seeks financing in the COT session by selling the stock to the COT financier at the closing price of the stock. The borrower commits to buy back the stock at a higher price the next day but has the option to roll over the position daily for up to 10 days. COT financing is for 100% of the share value without any margin. The difference between the purchase and sale prices is the return to the COT financier. As COT financing session takes place after the close of the regular market, the borrower is not assured of COT financing at the time of trade and may need to arrange financing from some other source. Both borrowers and financiers in the COT market transact through brokers. Those who provide COT financing are banks, development finance institutions (DFIs), NBFCs, and individuals. 26 SECP in February 2004 set up an expert committee, which released its report in October 2004 supporting the demutualization and integration of all three stock exchanges. An alternative model that was considered involved setting up a new national stock exchange. 8

3. Improve and Modernize the Securities Market Infrastructure and Promote Its Integration

28. This component (i) introduced automated trading systems in the stock exchanges; (ii) operationalized the central depository system (CDS); and (iii) developed the NCSS. The first two conditions were met during the program period. In conjunction with these achievements, the open outcry system was completely phased out in 1998 and replaced by computerized, screen- based systems, which improved the efficiency and handling capacity of the stock exchanges. Moreover, the stock exchanges have allowed the use of remote trading terminals, and are implementing Internet-based trading systems. NCSS was fully operationalized in December 2001. Delay in operationalization reflected the slower-than-expected implementation of TA Loan 1577-PAK(SF). Since January 2004, all securities in the CDS have also been added to NCSS. NCC, the operator of NCSS, was developed within CDC but is now being separated from it, with the information technology, the only shared function still handled by CDC. NCC is now modifying its systems in preparation for the implementation of the margin financing module.

29. LSE and ISE recently announced their integration plan. KSE, which has reservations about integration, has sought clarification from SECP on a few issues.

4. Develop the Corporate Debt Market

30. This component was intended to (i) set up a working group of market participants to devise a centralized electronic trading system, (ii) establish and develop an OTC debt market, and (iii) introduce prudential guidelines for the use of repurchase agreements in private debt securities. Whereas (iii) was implemented, (ii) was not vigorously pursued during the CMDP period and OEM could not independently verify if (i) had been implemented. The consulting team under TA Loan 1577-PAK(SF) concluded that an OTC debt market was premature considering the level of capital market development in the country. Since CMDP implementation, however, trading, clearing, and settlement systems and procedures have been developed for stocks and term finance certificates (TFCs), or corporate debt, on the OTC market.27 The legal framework is also in place. The OTC market is expected to be functional once securities are listed on the OTC Board. In view of these developments after the CMDP, (ii) is considered partially complied with.

5. Reform the Mutual Fund Industry

31. As envisaged under this component, (i) SECP has been given regulatory control over public and private sector mutual funds through the SECP Act, and (ii) the updating of the policy framework has allowed the emergence of sector-specific funds and liberalized investment requirements, thus facilitating portfolio diversification. Moreover, the management rights of all 26 funds of the state-owned Investment Corporation of Pakistan (ICP) were sold in three lots to private sector institutions from September 2002 to April 2003 (Appendix 3, Table A3.7). Representatives of ICP and the Privatization Commission are of the opinion that TA 2865-PAK (footnote 8) and TA Loan 1577-PAK(SF) contributed only marginally to this accomplishment, since they failed to offer practical solutions to bottleneck issues that caused delay in meeting this program requirement.

27 KSE has increased the paid-up capital requirement for securities to be listed on its Ready Board from PRs50 million to PRs200 million. This development should encourage small companies to seek a listing on the OTC market, where the minimum capital requirement is PRs10 million. The exchanges are now turning to leading corporate brokerage houses and professional firms that do consulting and advisory work on initial public offerings (IPOs) for help with market making for scrips to be listed on the OTC market. 9

32. According to the OEM, the following program measures were partially complied with: (i) strengthening of the regulatory framework of SECP and development of its monitoring and inspection capabilities, and (ii) privatization of mutual funds run by NIT. Those interviewed by the OEM gave mixed feedback about the first measure. So far, SECP has made no on-site inspection of any mutual fund. As to the second measure, the Privatization Commission has developed a plan that would split NIT into sub-funds, hand over management rights of some sub-funds to the large unit holders in lieu of letters of comfort for a minimum guaranteed price, and sell management rights of the remaining funds to the private sector. Once this plan is approved by higher authority, the Privatization Commission will take the transaction to the market.

6. Develop the Leasing Industry

33. Under this component the CMDP (i) transferred regulatory control of the leasing sector to SECP, (ii) secured compliance with increased capital requirements and prudential norms, and (iii) set the legal framework for asset-backed securities. Moreover, SECP urged LAP to collaborate with SECP to strengthen (i) industry standards for credit administration, pricing, and portfolio and asset-liability management; and (ii) lessor’s right of repossession. However, as LAP did not take any substantial action, SECP addressed these issues instead in the prudential regulations for NBFCs.

7. Promote Contractual Savings through Reforms of the Insurance Sector, and Pension and Provident Funds

34. The key CMDP achievements in insurance reform were (i) progressive increase in the minimum paid-up capital requirement for insurance companies, and (ii) corporatization of the state-owned National Insurance Company Limited (NIC) and Pakistan Insurance Corporation (PIC). In conjunction with the corporatization, PIC was renamed Pakistan Reinsurance Company Limited. TA 2866-PAK (footnote 9) complemented these achievements. Another key program measure, i.e., the establishment of an independent regulator for the insurance sector, was implemented with a major modification: the Government withdrew its original plan to establish the Pakistan Insurance Regulatory Authority (PIRA) and instead assigned SECP to regulate the insurance industry through an amendment to the SECP Act. However, the oversight arrangement over the insurance industry remains unclear. SECP and MOC have issued their own rules while SECP has neither significant enforcement powers nor the power to revoke licenses. Neither the Pakistan Insurance Institute nor the setting of industry standards has been upgraded as envisaged under CMDP.

35. The implementation of TA 2867-PAK (footnote 10) was a key CMDP measure in the area of pension and provident funds reform. However, according to the TA performance audit report (footnote 17), “the TA made negligible impact and sustainability of its outputs is assessed as less likely.” Accordingly, there was little progress in reform during CMDP. Subsequently, SECP issued the Voluntary Pension Fund Rules 2004 supported under FMGP, permitting asset allocation based on the age profile of participants. Under these rules, asset management companies and life insurers can register with SECP as managers of voluntary pension funds.

C. Cost and Scheduling

36. The RRP estimated the adjustment costs associated with CMDP at $514 million, comprising (i) revenue losses from tax reforms on selected financial instruments ($250 million); 10

(ii) increased cost of Government financing as a result of NSS rationalization and the relaxation of investment guidelines for institutional investors ($40 million); (iii) settlement of liabilities of NIT ($100 million) and ICP ($40 million); (iv) severance payments to employees laid off from NIT, ICP, CLA, and Controller of Insurance ($5 million); (v) modernization and automation of stock exchanges ($12 million); (vi) setup cost of NCSS and the OTC market ($10 million); and (vii) cost of transforming CLA to SECP, establishing PIRA, and strengthening the Pakistan Insurance Institute ($10 million). To fill the financing gap, the Export-Import Bank of Japan considered cofinancing of up to $250 million. However, this did not materialize. The OEM could not verify either the actual cost associated with the CMDP or the use of the counterpart fund generated out of the loan, as the Government did not earmark the loan for any particular purpose.

37. The second tranche of $125 million was disbursed on 22 June 2000, 6 months later than originally scheduled.28 The delayed program measures (as conditions for the release of the second tranche) concerned (i) capital market regulations and enforcement, (ii) operationalization of NCSS, (iii) privatization of the mutual funds run by NIT and ICP, (iv) finalization of insurance legislation, and (v) corporatization of NIC and PIC. The slower-than-expected progress in (i) and (ii) were closely related to the delayed implementation of TA Loan 1577-PAK(SF). Delayed implementation and partial success in TA 2865-PAK (footnote 8) slowed progress in (iii), while delayed implementation of TA 2825-PAK (footnote 7) and TA 2866-PAK (footnote 9) slowed progress in (iv) and (v) (footnote 17). 29

D. Organization and Management

38. All the agencies concerned supported the CMDP objectives. MOF, the Executing Agency, rationalized the NSS. SECP played a pivotal role in capital market and NBFC reforms. KSE, ISE, and LSE undertook governance reforms and significantly upgraded their infrastructure. MOC was responsible for insurance legislation and corporatization of state- owned insurance companies. The Privatization Commission carried out technical work on the privatization of ICP’s and NIT’s mutual funds. Interagency coordination was largely satisfactory. The Government has remained committed to the agreed reforms under the CMDP.

39. ADB devoted considerable resources to CMDP implementation. Over the program period, ADB maintained adequate policy dialogue with the agencies concerned through six review missions and regular correspondence. One processing mission member remained responsible for program implementation almost until the end of the program period. Representatives of SECP acknowledged that the continuity in ADB staff assignment had contributed to maintaining a close and constructive partnership.

40. The OEM deemed appropriate ADB’s assessment of compliance with the tranche and non-tranche conditions by the release of the second tranche. By the time of release, eight of 11 conditions tied to the disbursement had been fully complied with, one had been substantially complied with,30 and the remaining two conditions had been partially complied with.31 The OEM gave the following reasons to justify ADB’s decision to release the second tranche: (i) ADB had maintained adequate policy dialogue with the agencies concerned on all the outstanding

28 The RRP noted, “the second tranche, equivalent to $125 million, will be released over 1998 to 1999 period.” However, the Loan Agreement did not give this timeline for the release of the second tranche. 29 The TPAR (footnote 17) indicated the delayed completion of TA 2825-PAK by 16 months, TA 2865-PAK by 8 months, and TA 2866-PAK by 13 months. 30 This condition concerned capital market regulations and enforcement. 31 These conditions concerned (i) the establishment of NCSS, and (ii) the privatization of the mutual funds of NIT and ICP. 11

program measures; and (ii) the three remaining measures tied to the tranche release were in progress or under reconsideration. OEM also considered appropriate the extensions of the program period to allow the monitoring of unaccomplished non-tranche program measures. Most remaining items on the CMDP agenda (except privatization of NIT’s mutual funds) are being addressed under FMGP.

41. The RRP contained an inconsistency on the timeline for the release of the second tranche as noted in para. 8. Since the program summary of the RRP indicated a less onerous time frame than the 2 years envisaged in the policy matrix and the main text, the Government may not have put in the full effort needed to implement the 11 program measures tied to the release of the second tranche. Had the timeline been more consistently defined and closely managed, the Government might have implemented some of the program measures and TA Loan 1577-PAK(SF) more expeditiously.

III. ACHIEVEMENT OF PROGRAM PURPOSE

A. Performance Indicators

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

Table 1: Key Statistical Data

Item Unit FY1994−FY1996 FY1997−FY2002 FY2003 FY2004 A. Performance Indicators of CMDP 1. Number/Size of Equity IPOs Number/Size 37−59 0−8 2 10 (PRs million) 3,208−11,044 0−1,418 311 10,466 2. Average Daily Trading Volume Million shares 6.5−22.9 33.9−192.7 214.4 387.1 3. Market Capitalization (at end of period) % of GDP 17.6−25.9 8.2−20.3 15.7 26.0 4. Compliance with G30 — — 8 of 9 conditions Recommendations complied witha 5. Total Investments in Lease Finance % of GDP 0.81−0.96 0.8−1.09 0.74 0.81 6. Total Mutual Funds’ Assets % of total — 1.47–3.33 2.90 4.32 bank deposits 7. Total Premiums Collected by General PRs billion 6.7–9.1 9.4–15.3 19.6 22.0 Insurance Companies

32 There was a surge in equity IPOs in FY1994–FY1996. This was the period of large foreign portfolio investments following the opening of equity markets to foreign investors in the early 1990s. The high domestic interest rates during these financial years made equity finance attractive. 12

Item Unit FY1994−FY1996 FY1997−FY2002 FY2003 FY2004 8. Total Premiums Collected by Life PRs billion 4.5–6.5 5.9–7.8 10.0 11.8 Insurance Companies

B. Memorandum Items 1. KSE-100 (at end of period) 1,607−2,331 880−1,770 3,402 5,279 2. Equity Subscriptions Received PRs million 9,949−40,739 0−1,134 1,193 46,470 3. Number/Size of TFC IPOs Number/Size 0−2 1−17 21 3 (PRs million) 0−175 50−2,250 2,025 400 4. Treasury Bill Yield: 6-Monthb % 10.8−15.1 6.5−16.3 1.7 2.2 — = not available, CMDP = Capital Market Development Program, G30 = Group of Thirty Consultative Group on International Economic and Monetary Affairs, Inc., GDP = gross domestic product, IPO = initial public offering, TFC = term finance certificate. a International Securities Services Association (ISSA). 2003. ISSA Pakistan Handbook, Eighth edition. Zurich. The condition not complied with concerns the real-time gross settlement system and trade netting system provided for in this handbook. b Average of auction cutoff yields in June. Source: Appendix 3.

43. Stock market transactions have significantly increased since CMDP implementation. However, strong demand for equity securities has not been matched by a supply of fresh issues. Equity subscriptions were four times the size of equity IPOs from FY2002 to FY2004. The immediate reason for this demand-supply gap in the stock market was a substantial reduction in interest rates, leading to a secondary stock market rally during this period. The CMDP achievements, together with favorable macroeconomic and external conditions, also contributed to this rally.

44. Though market capitalization has grown significantly in recent years, the Government’s shareholding still represents about 50% of the market capitalization33 of KSE-100. Moreover, the Government remains the largest raiser of funding through the primary equity market, comprising more than 60% of IPO value during FY2002–FY2004,34 and there were also secondary offerings and direct sale of shares of listed companies by the Government. IPO issuance by the private sector has been relatively small; market participants have given the following reasons for this: (i) very low interest rates and easier credit conditions, encouraging companies to make greater use of bank loans for their financing needs; (ii) the phaseout of the fiscal incentive of a lower tax rate for listed companies with the unification of corporate tax rates; and (iii) stricter corporate governance and reporting requirements for listed companies.

45. The Pakistan stock market experienced a major bullish run in early 2005. The KSE-100 index, which surged by 65% from January 2005 to a peak of 10,303 on 15 March 2005, fell by about 35% to 6,725 on 13 April 2005. To investigate this incident, SECP has immediately formed a task force, which submitted the report to SECP in June 2005. The report highlighted the remaining weakness in market governance. On this basis, SECP has penalized several stock brokers. OEM interviewees had divergent views on the market situation. Some said that futures contracts had caused the excessive volatility in the market. Others believed that the sharp rise and subsequent drop of stock prices had been manipulated by a few large market players. Some interviewees criticized SECP and SBP for not taking preemptive policy actions to check the accelerated rise in the market before it crashed. On the positive side, the KSE management took credit for the fact that no broker had defaulted during the market crash; their stringent risk management measures averted broker default, the KSE said. Against the 30

33 OEM estimates based on stock prices as of 6 May 2005. 34 This refers to the IPO of the Pakistan Oil and Gas Development Company Limited in 2003. 13

March 2005 settlement of PRs30 billion, which was the highest single settlement in KSE’s history, NCC had PRs10 billion in the form of margins already collected from members.

B. Program Outcomes

1. Create an Enabling Policy Environment to Enhance Competition and a Level Playing Field

46. The survey results confirmed the contribution of the CMDP to an improved policy environment by increasing competition and creating a more level playing field. Interviewees especially acknowledged the following CMDP measures: (i) the easing of investment restrictions for employee provident funds and life insurance companies, (ii) the rationalization of tax anomalies in the equity market, (iii) the rationalization of the tax regime for mutual funds, and (iv) the reform of the interest rate and tax structures of NSS. Aside from CMDP, most interviewees considered the elimination of institutional investments in NSS, in place since March 2000, as the most important contributory factor. Net investment in NSS increased from PRs37 billion in FY1994 to PRs140 billion in FY1999 but declined to PRs257 million in FY2004 and has shown a net withdrawal in FY2005 (Appendix 3, Table A3.8).35 Overall, the performance of this component was satisfactory.

2. Strengthen Securities Market Governance, Institutions, Regulations, and Supervision

47. The survey results confirmed the substantial improvement in market institutions, regulation, and supervision that resulted from CMDP. Interviewees unanimously held the view that the creation of SECP was the main factor. Overall, the performance of this component was satisfactory.

48. Off-sight inspection and investigations led the SECP in 2004 to (i) penalize brokers and suspend their license for violations of the Securities and Exchange Ordinance of 1969 and its Rules and Regulations; (ii) issue warnings to the management and board of directors of a listed company for the improper dissemination of price-sensitive information; and (iii) impose a fine of PRs535,000 on a financial institution for involvement in insider trading in the shares of a listed company (the first proven case of insider trading in the history of the capital market in Pakistan). To further strengthen its enforcement and investigative capacity, the SECP is now in contact with international firms for the purchase of a tailor-made market surveillance system, which will be customized to suit local needs.

49. In the area of on-site inspection, SECP has started implementing a comprehensive inspection plan for members of the stock exchanges to protect investors by maintaining fair, orderly, and efficient dealing by brokers and agents at the stock exchanges. Moreover, SECP has fully implemented a risk-based methodology for selecting and setting examination and inspection cycles for brokers and agents. These inspections have addressed the compliance problems and system loopholes. SECP intends to inspect the operations of about 5% of the members/brokers of each stock exchange yearly.

50. SECP has vigorously pursued institutional capacity building in response to claims from some market participants that its institutional development has not fully kept pace with market developments in recent years. In FY2003–FY2004, SECP recruited 63 officers with expertise in

35 NSS showed a net withdrawal of PRs8 billion in the first 8 months of FY2005 up to February 2005. 14 chartered accountancy, business administration, law, and information technology. New staff included professionals with knowledge of market surveillance, inspection and broker registration, commodity exchange, and NBFC regulation. SECP employees have also undergone training in-house and abroad.

51. As regards rules and regulations, SECP has recently approved (i) Clearing House (Registration and Regulation) Rules of 2004, (ii) Margin Trading Rules of 2004, (iii) Margin Trading Regulations of 2004, (iv) Property Trading Regulations of 2004, (v) Regulations for System Audit of Brokers of the Exchanges of 2004, (vi) NCSS Regulations of 2004, and (vii) Internet Trading Guidelines of 2005.

52. Stock exchanges adjusted their management structure, and are now carrying out the system audit of brokerage houses. However, the stock exchanges still suffer from generally poor public perceptions about their governance and transparency, and their self-regulatory functions are weak. SECP believes that excessive autonomy granted to regional, mutualized stock exchanges may create self-interest clubs, and is therefore actively pursuing demutualization. Considering all these achievements and the SECP’s ongoing efforts, the overall performance of this component was satisfactory.

3. Improve and Modernize the Securities Market Infrastructure and Promote Its Integration

53. All the survey interviewees noted major improvements in market infrastructure. They acknowledged the significant contribution of the CMDP, and shared the view that automated trading had improved price transparency in order execution while CDS had reduced the incidence of fraud related to counterfeit shares in physical deliveries. The OEM believed that the implementation of the margin financing module by NCC would contribute to further efficiency gains in the stock market. Overall, the performance of this component was satisfactory.

4. Develop the Corporate Debt Market

54. The issuance of listed TFCs, or corporate bonds, increased during FY2001–FY2003 but declined substantially from FY2004 onward (Appendix 3, Table A3.2). Though these TFCs are listed on the stock exchanges, there is virtually no secondary market in these instruments. According to market participants, the very low interest rates (Appendix 3, Table A3.10) made bank loans more attractive and, hence, were the key factor behind the decline in TFC issuance. In FY2003–FY2004, PRs2.4 billion was raised in TFC IPOs versus a PRs386 billion increase in private sector borrowing from banks. As envisaged under the CMDP, SECP has approved the listing of TFCs on the OTC market. SECP expects the trading of TFCs to make the corporate debt market more vibrant, efficient, and liquid. Overall, the performance of this component was partly satisfactory.

5. Reform the Mutual Fund Industry

55. The mutual fund industry has witnessed strong growth in recent years, reflected in the increased participation of the private sector with the launch of new funds and the expansion in the aggregate value of mutual funds (Appendix 3, Table A3.3). This growth was attributed partly to the privatization of the closed-end mutual funds that used to be managed by ICP. As noted earlier, the finalization of the transaction structure for the privatization of the open-end mutual fund managed by NIT has been delayed. However, perhaps reflecting the expectation that the fund will be privatized soon, open-end funds have also grown in recent years. Most market 15 participants interviewed by OEM considered the barring of institutional investment in NSS and the buoyant equity market as major contributors to the growth in the size of the mutual fund industry. Overall, except for the delay in the restructuring of NIT, the performance of this component was satisfactory.

6. Develop the Leasing Industry

56. Whereas the GDP share of leasing assets largely remained constant from FY1994 to FY2004 (Appendix 3, Table A3.6), leasing companies’ profitability has significantly improved in recent years (Appendix 3, Table A3.5). The interviewees acknowledged the contribution of CMDP measures in (i) streamlining the regulatory framework, (ii) strengthening the capital base, and (iii) developing alternative long-term financing sources for the industry. The transfer of the regulatory responsibility for leasing from SBP to SECP has facilitated these developments. SECP has developed some capacity to effectively regulate the leasing industry by employing people from the industry. However, its capacity for on-site examination needs to be further strengthened. Overall, the performance of this component was satisfactory.

7. Promote Contractual Savings through Reforms of the Insurance Sector, and Pension and Provident Funds

57. The total gross premiums collected by general insurance companies substantially increased from PRs6.7 billion in 1994 to PRs22 billion in 2004 (Appendix 3, Table A3.4). From 1996 to 2004, the number of general insurance companies fluctuated between 49 and 62, while the market share of NIC has been constant at around 17–19%. The total gross premiums collected by life insurance companies increased from PRs4.5 billion in 1994 to PRs11.8 billion in 2004. During this period, the number of general insurance companies increased from three to five, while the market share of State Life Insurance Corporation was progressively reduced from 98% to 70%. OEM could not obtain the relevant quantitative data on pension and provident funds. Despite the steady growth of the insurance industry in the last decade, survey interviewees did not particularly acknowledge the contribution of CMDP. They instead pointed out a continued weakness in the regulatory framework of the insurance industry as well as the continued predominance of state-owned life insurance and reinsurance companies. Nonetheless, they considered the development of the capital market, as an outcome of CMDP, to be conducive to the promotion of contractual savings. Market participants also see the potential of the insurance and pension industry and expect further progress in reforms under the FMGP. Overall, the performance of this component was partly satisfactory.

C. Sustainability

58. Most policy achievements discussed in paras. 23–35 appear to be sustainable considering (i) the Government’s continued commitment to the program purpose demonstrated through follow-on policy measures, and (ii) stakeholders’ support for the program achievements. However, the gains brought by sound capital market development remain at risk from the growing high-profile financial crimes and new forms of market manipulation as witnessed during the recent market upheavals. Based on lessons learned from this experience, SECP is further strengthening its surveillance function and enforcement of rules supported under the FMGP.

16

D. Technical Assistance Loan

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

IV. ACHIEVEMENT OF OTHER DEVELOPMENT IMPACTS

A. Organizational Impact

60. The CMDP contributed to (i) the conversion of CLA to SECP, and the empowerment of SECP as an independent oversight institution for the capital market and NBFCs, (ii) the enhancement of accountability and the improvement of operations at the stock exchanges, (iii) the establishment of CDC and NCSS, (iv) the restructuring of ICP and NIT, and (v) the corporatization of PIC and NIC. But CMDP did not effectively support the development of SROs in the capital and financial markets.

B. Socioeconomic Impact

61. ICP has reduced the number of its staff from more than 600 to 49 in two golden- handshake phases in conjunction with the privatization of its mutual funds. NIC has reduced its staff strength from 600 to 400 in conjunction with corporatization. On the other hand, PIC corporatization has not led to a reduction in staff strength. The survey results suggest that the stock market rally in recent years contributed significantly to job creation in the industry and to the broadening of the investor base in the country including individuals.

V. OVERALL ASSESSMENT

A. Relevance

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

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B. Efficacy

63. The OEM confirmed full compliance with 46 out of the 58 policy conditions, and considered the outcomes of five (of the seven) CMDP components satisfactory. These components concerned (i) competition and level playing field; (ii) securities market governance, institutions, regulations, and supervision; (iii) securities market infrastructure; (iv) the leasing industry; and (v) mutual funds. But the insurance and pension reforms component and the corporate debt market component were only partly satisfactory in the OEM’s view. The performance indicators and other relevant data suggest largely satisfactory achievement of the CMDP purpose. Overall, therefore, the OEM assessed the CMDP as efficacious.

C. Efficiency

64. The OEM considered the CMDP efficient for two main reasons: (i) the program effects relative to costs met the expectations of the Government and stakeholders; and (ii) interagency coordination, monitoring and reporting, policy dialogue, and ADB’s disbursement decision at the release of the second tranche release—the various elements of program management—were appropriate. OEM also considered appropriate the extensions of the program period to allow the monitoring of unaccomplished program measures. SECP noted that continuity in staff assignment on the ADB side contributed to maintaining a close and constructive partnership. If the associated TA loan had more effectively complemented program implementation, the CMDP could have been assessed as highly efficient.

D. Sustainability

65. The OEM deemed the sustainability of CMDP accomplishments likely, given the assessment presented in para. 58.

E. Institutional Development and Other Impacts

66. The OEM considered the organizational development and other impacts of the CMDP significant in view of the assessment presented in paras. 60–61.

F. Overall Program Rating

67. On the basis of the above, the overall rating of the CMDP is successful.

G. Assessment of ADB and Borrower Performance

68. MOF, MOC, SECP, the Privatization Commission, the three stock exchanges, and CDC all performed their expected roles under the CMDP, while coordinating with one another. SECP’s ownership of reforms, supported by a favorable political economy of decision making, was especially noteworthy. The OEM also noted (i) the Government’s continued commitment to the CMDP purpose demonstrated through follow-on policy actions, and (ii) stakeholders’ support for the CMDP achievement. From these observations, the OEM assessed the performance of the borrower as satisfactory.

69. ADB’s performance in CMDP formulation and implementation was generally appropriate and associated with good practices (para. 79). Representatives of the relevant agencies acknowledged the significance of policy dialogues with the ADB officers concerned, who had in- 18 depth understanding of bottleneck issues that the country and its institutions faced. Given this feedback from borrower representatives, the OEM found the performance of ADB satisfactory.

VI. ISSUES, LESSONS, AND FOLLOW-UP ACTIONS

A. Key Issues for the Future

1. Capital Market Regulation and Governance

70. Since its transformation from CLA in 1997, SECP has played a pivotal role in bringing about visible reforms in the capital market and corporate affairs. The current regulatory architecture deviates from that originally envisaged under the CMDP, which emphasized self- regulation by market participants. This deviation can be justified in view of the slow progress in creating a functional self-regulatory mechanism and the rapid market growth in recent years. SECP needs to further enhance its capacity for market surveillance and enforcement of regulations and rules, especially through on-site examination. To effectively and efficiently exercise this function, SECP should set up office in Karachi. This would also enhance consultation with market participants, possibly leading to a more market-friendly regulatory environment. In pursuing good corporate governance and responsible market practices SECP may also consider fixing the qualification criteria for market analysts and financial reporting standards.

71. Stock exchanges significantly improved their operational efficiency and undertook governance reforms as envisaged under CMDP. However, a self-regulatory mechanism has not been effectively put in place. The OEM held the view that a workable and viable self-regulatory framework presupposes demutualization to increase the accountability of the stock exchanges. Inherent conflicts of interest observed in regional, mutualized stock exchanges may threaten the basic objective of ensuring a transparent and efficient market for investors. The OEM therefore supported demutualization.

2. Regulation on NBFCs and the Insurance Industry

72. Under the NBFC Rules 2003, SECP is responsible for governing investment finance services, leasing, venture capital investments, discounting services, investment advisory and asset management services, and housing finance services. However, its broad oversight functions have been constrained by the small number of experts in those businesses. On-sight inspection of NBFCs especially needs significant upgrading.

73. Several of those interviewed by OEM underscored the need to improve the policy and regulatory framework for mutual funds, by (i) streamlining the process of approving investment schemes, (ii) formulating rules for specialized funds such as hedge funds and real investment trusts, and (iii) rationalizing the rules for the conversion of a closed-end fund into an open-end fund. The survey results suggested that the industry lacked fund management skills and stressed the need to license fund managers on the basis of appropriate criteria. The interviewees all believed that, despite growth in the size of mutual funds, the investor base had not broadened. Market participants traced this to the weak return performance of mutual funds and the very small distribution network. Improvement in these areas would enhance the overall efficiency of the mutual fund industry.

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74. The oversight arrangement in the insurance industry remains unclear; SECP and MOC have issued their own rules but SECP has neither significant enforcement powers nor the power to revoke licenses. This dichotomy has fueled uncertainty and weakened the ownership of the regulatory framework. SECP’s exercise of its regulatory function is not made any easier. From this perspective, the Government is considering transferring jurisdiction from MOC to MOF as an alternative regulatory arrangement. This is expected to clarify an issue that could cause a regulatory loophole.

3. Development of the Primary Equity Market

75. Though the flow of primary equity offerings has increased in FY2004–FY2005, the supply has been smaller than demand. Recent IPOs have been heavily oversubscribed as a result. In terms of value, the listing of Government-owned entities has dominated fresh offerings while equity IPOs in the private sector have been relatively small. The capital market, it would seem, remains below its potential in mobilizing the resources of the non-state corporate sector. The OEM therefore supported SECP’s recent initiative to assess the remaining impediments to the development of the primary market.

4. Development of the Debt Market

76. While the NSS no longer corners investible funds from institutional investors, the debt market has not appeared to develop as a full substitute. The size of the corporate debt market vis-à-vis private sector bank credit is very small, and secondary market liquidity is virtually nonexistent. Though TFC issuance started picking up in FY2001, it declined in FY2004– FY2005. Identifiable factors behind the slower-than-expected development of the corporate debt market include (i) high issuance costs associated with stamp duties, brokerage fees, bank commissions, and prospectus publication and distribution, which become more prohibitive for shorter-term securities; and (ii) the limited distribution system for debt securities in general. Moreover, some banks indicated concerns about the recent approval of TFC listing on the OTC market in view of (i) anonymity of trades, (ii) settlement risk, and (iii) delivery versus payment. SECP and the stock exchanges should tackle these issues in consultation with market participants.

5. Level Playing Field

77. The rationalization of the NSS under the CMDP contributed significantly to a more level playing field across financial instruments. But there are still some distortions, such as (i) the small prepayment penalties on the premature withdrawal of investment in NSS, (ii) the capital gains tax levied only on insurance companies, and (iii) zakat (religious levy) imposed on private mutual funds but not on public sector funds. In relation to (i), the NSS instruments can be prematurely encashed at face value with the only penalty being a lower interest rate depending on the term. This provides price protection against adverse movements in interest rates. For listed fixed-income securities, on the other hand, price variations with changing interest rates are much greater.

6. Market Irregularities

78. With technology, the risk of growing high-profile financial crimes and new forms of market manipulation cannot be discounted. The report of the Stock Market Review Task Force, issued in June 2005, attributed the recent upheavals in the stock market partly to manipulated and syndicated activities of market participants. Apart from the market upheavals, market 20 participants generally believe that market irregularities are still prevalent. SECP has recently taken punitive actions against specific instances of insider trading and price manipulation, but monitoring and surveillance activities in this regard could stand further strengthening.

B. Lessons Identified

79. The OEM attributed the success of CMDP to SECP’s ownership and leadership in reforms, supported by a favorable political economy and effective policy dialogues. The key ingredients of the effective dialogues were the following: (i) ADB processing missions gained enough knowledge about the country from the economic and sector work mission that preceded the reconnaissance mission; (ii) the reconnaissance mission had extensive policy dialogues with the agencies concerned, especially CLA, and broad consultations with stakeholders; (iii) the policy matrix was drafted at an early stage of processing, and the Government took substantial actions before loan approval; (iv) ADB processing and review missions made an effort to come up with alternative policy measures, which led to realistic solutions while also enhancing ownership of reforms; (v) one ADB processing mission member remained responsible for program implementation almost until the end, contributing to a close and constructive partnership; and (vi) ADB continued to monitor unattained non-tranche program measures by extending the loan closing date (which was 16 months after the release of the second tranche). All these are considered good practices for ADB’s policy-based lending.

80. The RRP identified the following performance indicators for the CMDP: (i) the number and size of equity IPOs, (ii) daily trading volume, (iii) market capitalization, (iv) compliance with G30 recommendations, (v) total investments in leasing assets, (vi) total assets of mutual funds, and (vii) the number of insurance policyholders and the premiums collected by insurance companies. These indicators alone are inadequate for an analysis of the extent to which the development of the capital market can be attributed to the CMDP. A benchmark interest rate and data showing the investors’ demand for equity instruments, for instance, should have been included. The amounts of equity subscriptions, which were four times larger than the size of IPOs during FY2002–FY2004, reflected low interest rates and contributed to the significant increase in transactions in the secondary market. Other important aspects of the recent development of the capital market are the following: (i) the Government’s shareholding represents about 50% of the market capitalization of KSE-100, and (ii) the listing of Government entities represented the majority of IPO values from FY2002 to FY2004. These suggest that the capital market remains below its potential in mobilizing the resources of the non-state corporate sector. The absence of any analysis of these aspects weakens the PCR assessment of the capital market development.

81. The establishment of workable self-regulatory market institutions was one of the few unfulfilled items on the CMDP agenda. The SECP believes that excessive autonomy granted to regional, mutualized stock exchanges may create self-interest clubs, and is therefore actively pursuing demutualization before the exchanges’ self-regulation replaces some of the SECP’s regulatory oversight. This approach could apply to other developing countries pursuing capital market governance reforms, depending on the ownership and management structure of their stock exchanges.

82. Delays in the implementation of related stand-alone TAs and TA Loan 1577-PAK(SF) impeded timely compliance with the relevant conditions for the release of the second tranche under CMDP. This experience underscores the need for timelines that are realistic and consistent between programs/projects and the TAs/TA loans that are meant to complement the programs/projects. 21

83. The lack of verifiable outputs and records from both the implementing agencies and ADB hampered the evaluation of TA Loan 1577-PAK(SF). Presumably for this reason, no overall rating was given to the TA loan in the PCR on CMDP. No separate project completion report was prepared for this TA loan. To the OEM, this could reflect a general weakness in ADB’s self- evaluation of TA loans attached to project or program loans in view of the observations presented in the next paragraph.

84. ADB’s Project Administration Instructions (PAIs) do not distinguish between a TA loan and other types of loans as to their standard requirements for project completion reports (PAI 6.07). Likewise, the PAI does not distinguish between a stand-alone TA loan and a TA loan attached to a project or program loan. Hence, all TA loans should have separate project completion reports in accordance with the General Guidelines for Preparing Project Completion Reports (project, multi-project, sector, program, sector development program, and TA loans) (PAI 6.07, Appendix 2) revised in August 2001.36 Since then, self-evaluation of eight attached TA loans has been conducted. However, self-evaluation of six (including TA Loan 1577- PAK[SF]) of the eight was subsumed in the four PCRs37 of associated program loans, and only two TA loans have separate project completion reports 38 following their salient features as defined in PAI 6.07.

85. The OEM did not identify the need for any significant follow-up action.

36 Before the revision in August 2001, the General Guidelines did not refer to TA loans. 37 ADB. 2002. Program Completion Report on the Financial Intermediation and Resource Mobilization Program and Commercial Bank Audits to the Kyrgyz Republic. Manila; ADB. 2002. Program Completion Report on the Public Sector Reform Program to the Solomon Islands; ADB. 2002. Program Completion Report on the Trade Export Promotion, and Industry Program in Pakistan. Manila; and the PCR on Loan 1576-PAK and TA Loan 1577- PAK(SF) (footnote 11). 38 ADB. 2003. Project Completion Report on Institutional Strengthening of the Financial Sector to the Republic of Korea. Manila; and ADB. 2003. Project Completion Report on Upgrading Skills and Systems of Commercial Banks in Mongolia. Manila.

22 POLICY MATRIX

First Tranche- Second Tranche- Program Program Appendix 1 Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM)

I. Create an Enabling Policy Environment to Enhance Competition and a Level Playing Field Liberalize I.A.1. Lower the I.B.1 Reduce this Implemented. Complied with. investment mandatory investment restrictions on investment restriction further The Insurance Ordinance of 19 August 2000, Implemented measures remain in place with no institutional requirements for by 10%. June set the minimum investment requirement for further changes in investment limits, i.e., life investors. life insurance 1998.c life insurance companies in Government insurance companies are required to maintain at least companies in securities at 40% of their investible funds. 40% of their investible funds in Government Government and Subsection 7 of section 35 of the Ordinance securities or in a combination of Government Government- empowers the federal Government to securities and other approved securities. approved prescribe a percentage of the shareholders securities from funds or of a statutory fund of a life insurer to 60% to 50% of be invested in Government securities or in a their investible combination of Government securities and funds. June other approved securities; subsection 8 1997.b provides for mandatory limits of not more than 40%. Immediately before the promulgation of the Ordinance, the minimum requirement was 50%; in 1997, it was 60%.

I.A.2. Raise the I.B.2 Raise this Implemented. Complied with. investment cap for investment cap provident funds in further to 30%. Employees’ Provident Fund (Investment in The Employees Provident Fund (Investment in Listed stocks and listed June 1999.c Listed Securities) Rules of 1996, which Securities) Rules of 1996 were amended through corporate fixed- provided for 10% investment of provident Statutory Regulatory Order 410(I)/97 dated 6 June income securities funds in listed securities were amended in 1997 and the limit for investment in listed securities from 10% to 20% 1997 and the maximum limit was raised to was raised from 10% to 20%. The same regulatory of their investible 20%. In November 1998, the limit was raised order also did away with the restriction that funds; and within further to 30%. In 1997, the maximum investment in any one company or instrument should this cap, raise the investment limit of 1% in the listed securities not exceed 1% of the provident fund. However, a new limit on investment (both equity and fixed income) of a company condition was that investment in shares or other listed in listed corporate was also removed. securities of a particular company should not exceed fixed-income 5% of its paid-up capital. The limit for investment in securities from 1% listed securities was further raised from 20% to 30% to 5%. June through Statutory Regulatory Order 1260(I)/98 dated 1997.b 2 November 1998.

First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) The Rules were further amended through Statutory Regulatory Order 261(I)/2002 dated 10 May 2002, which allowed provident funds to invest up to 50% of the provident fund in unit trust schemes registered under the Asset Management Companies Rules of 1995 but set an upper limit on investment in any one unit trust scheme at 25% of the provident fund.

More recently, the Voluntary Pension System Rules of 2004 issued by the Government revised the parameters for asset allocation.

I.A.3 Allow listed State Bank of Pakistan’s (SBP) Rules of Complied with. corporate fixed- Business for NBFIs make listed debt income securities securities (corporate fixed-income securities) Implemented measure remains in place with no to be treated as eligible investments for meeting the statutory further changes. For the statutory liquidity ratio (SLR), eligible liquidity requirements of NBFIs. Provident Rule 6 of the Rules of Business for NBFIs amended investments for funds can also be invested in listed corporate through the Banking Policy and Regulations the purpose of fixed-income securities. Department Circular No. 17 dated 10 June 1997 also meeting the allows NBFIs to invest in listed debt securities aside statutory liquidity from Government securities, shares of listed requirement for companies, and National Investment Trust Limited nonbank financial (NIT) units. However, total investment in listed institutions securities should not exceed 1% of the total liabilities. (NBFIs) and for investment Employees’ Provident Fund (Investment in Listed requirements of Securities) Rules of 1996 issued on 26 February provident funds. 1996 allow provident funds to invest in listed June 1997.b corporate fixed-income securities provided they have been rated as investment-grade with a minimum rating of “BBB” by a credit rating agency registered with the Securities and Exchange Commission of

Pakistan (SECP). 1 Appendix

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24 First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) Appendix 1 Rationalize I.A.4 Implement I.B.3 The Implemented. Complied with. tax anomalies the following key Government will in the equity tax reforms: study the stamp (i) After extending exemption from capital The Finance Bill of 2004–2005 extended capital gains market. (i) extend duty structure of gains tax on listed securities until 2001, in tax exemption until 2007. exemption from the federal area 1997, the Government further extended capital gains tax and the provinces, exemption till 2004. As part of its FY2005 federal budget, the Government on listed securities and recommend levied a tax on the purchase of listed shares effective on the stock rationalization of (ii) Tax on bonus shares and turnover tax on July 2004. This capital value tax, as announced with exchange at least the tax rates on shares were abolished through the Finance the budget, was 0.1% of the purchase price of the until 2001; financial Act of 1997. shares. However, because of strong opposition to this (ii) abolish the tax transactions and measure from stock market participants, the on bonus shares asset-backed (iii) Stamp duty being a provincial subject, all Government reduced the rate to 0.01%. The and earnings from securities. June provincial governments were advised to Government also levied a 10% withholding tax on the sale of rights 1999.c reduce the stamp duty on the transfer of financing of carry-over transactions (COT) effective shares, as well as securities for CDC transactions from 1.5% to July 2004. the 0.5% turnover 0.1%. The governments of Sindh, Punjab, tax on shares; and and North-West Frontier provinces as well as The Working Group on Money and Debt Market (iii) for the the Federal Area Administration notified a Development has made several recommendations for provinces, reduce reduction in stamp duty. The exception is the the development of debt market and reduction of the stamp duty on province of Balochistan, where only a few stamp duty. SECP and the Ministry of Finance (MOF) the transfer of companies are incorporated. Policy action are carrying out active consultations on these securities for regarding stamp duty structure was partially recommendations with the provincial governments. Central Depository implemented. No formal study of stamp duty Company of structure was undertaken. However, the Pakistan Ltd. federal Government has been advising the (CDC) provincial governments to make necessary transactions from changes in the stamp duty rates in response 1.5% to 0.1%. to the market requirements, particularly to June 1997.b promote new financial instruments, as in the issuance and trading of term finance certificates (TFCs). As regards rationalization of tax rates on asset-backed securities, significant tax concessions have been announced through the Finance Ordinance of 2001, which allows tax deductions on payments to special-purpose vehicles on behalf of the originator. Payment on account of securitization of receivables by special- purpose vehicles has been exempted from withholding tax.

First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) Rationalize I.A.5 Abolish the I.B.4 The Implemented. Complied with. tax and (i) 10% Government will interest rate withholding tax on adopt a suitable Major policy changes involving rationalization Implemented policy measures remain in place: structure rated and listed mechanism to of the tax structure have been introduced in (i) uniform rate of withholding tax of 10% on profit anomalies in corporate fixed- adjust interest the NSS. Interest on different NSSs has been from both NSS and corporate debt securities, though the debt income securities rates for NSS, to significantly reduced. Since 1999, interest on NSS investments less than Pakistan rupees market. to bring them at realign returns 10-year defense savings certificates (DSC) (PRs)150,000 are exempt from tax; (ii) semiannual par with the with an has been reduced four times: from 18% in revision of NSS rates to align them with yields on national savings appropriate May 1999 to 16% in December 1999, to 15% equivalent-tenor Government bonds called PIBs; and scheme (NSS), benchmark, while in January 2000, to 14% in July 2000, and to (iii) ban on institutional investment in NSS. which is currently maintaining 11.6% in June 2002. The Government has exempt from this uniform tax decided to review the rate of return every 6 Since the NSS rate revision in June 2002, the tax; and (ii) tax on treatment for NSS months and keep it in line with the interest on Government has revised NSS rates four times: on 10- interest income and rated and the Pakistan investment bond (PIB), which is year DSCs, from 11.6% in July 2002 to 10% in derived from listed private closely market related. Various NSSs have January 2003, 8.5% in July 2003, 7.96% in January government and corporate debt been linked to PIB of equivalent maturities. 2004, and 8.15% in July 2004. corporate fixed- securities. June While DSCs have been linked to 10-year PIB income securities 1998.c maturity, the regular income scheme has Further rationalization of NSS is being pursued under for foreign been linked to 5-year PIB and special savings the Financial Markets and Governance Program of investors. certificates/accounts have been linked to 3- the Asian Development Bank (ADB). September 1997.b year PIB. Rationalization of the rates of the NSS has greatly contributed to developing the corporate debt market. Withholding tax of 10% on all the NSS was imposed in 1999 but had to be withdrawn because of certain legal complications that were brought to the attention of the High Court. The main issue was that the Government had levied withholding tax on profit paid instead of profit accrued, which implied that the tax became leviable with retrospective effect. The Government has reimposed withholding tax

of 10% on all investments made since 1 July 1 Appendix 2001. However, to address the concerns of small investors, investments of up to PRs150,000 have been exempted from withholding tax. The Government has also prescribed varying rates of penalty on 25 premature withdrawals of investments in the regular income scheme.

26 First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) Appendix 1 In March 2000, the Government barred institutional investors from investing in the NSS. This measure has substantially

benefited the corporate debt market.

Rationalize I.A.6 To adopt Implemented. Complied with. the tax regime uniform tax for mutual treatment for The Government announced exemption from Implemented measures remain in place, i.e., both funds. public and private tax on income of private sector mutual funds public and private sector mutual funds are exempt sector mutual through the Finance Act of 1997. However, from income tax provided they distribute at least 90% funds, abolish the certain anomalies in Government policy of their profits (excluding unrealized capital gains). income tax for between public sector mutual funds and mutual funds private sector mutual funds remain. For provided they instance, zakat (religious levy) is leviable on distribute at least private sector mutual funds but not on public 90% of their sector mutual funds. Private sector mutual profits. June funds are also at a disadvantage compared 1997.b with NIT in certain aspects. Provident funds and surplus funds of charitable institutions can be invested in NIT but not in private sector mutual funds because of limitations imposed by income tax rules. Also, unlike the units of NIT, certificates and units of private sector mutual funds are not eligible for statutory reserve requirements of commercial banks.

II. Strengthen Securities Market Governance, Institutions, Regulation, and Supervision Develop II.A.7 The Implemented. Complied with. strong Corporate Law regulatory Authority (CLA) The CLA chairperson announced the major OEM confirmed the PCR finding. bodies for the will announce a components of the Capital Market Reform securities strategy and an Program at different forums, particularly market to action plan for seminars organized by professional bodies support the reforms in the and the stock exchanges. These events were orderly growth securities market also adequately covered in the press. of companies with a focus on Some of these forums were: and improve strengthening (i) Meeting of members of the Karachi Stock investor corporate Exchange (KSE) and representatives of confidence. governance and business and industry in Karachi. The finance regulations, and minister was also present (18 August 1997). reforming market (ii) Seminar organized by the Management infrastructure, Association of Pakistan in Karachi (26 August

First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) including 1997). modernization of (iii) KSE inauguration of the Karachi stock exchanges Automated Trading System (27 October through the 1997). adoption of (iv) General Assembly of Federation of Euro- automated Asian Stock Exchanges in Lahore (29 trading, clearing, October 1999). settlement, and (v) Meeting of members of KSE (13 depository December 1997). systems. October (vi) Pakistan Development Forum attended 1997.b by senior officials of multilateral institutions, including ADB. The reform program was also covered on television.

Modernize the II.A.8 Prepare and II.B.5 Establish Implemented. Complied with. supportive seek cabinet and operationalize legislation to approvald for the the SECP on the The SECP Act of 1997 was promulgated on The corporate structure of SECP has been evolving. improve creation of an basis of a 26 December 1997 after intensive At the time of its establishment, SECP was assigned enforcement autonomous and corporate plan discussions between the CLA and ADB. Its the regulation of capital markets and the corporate by the SECP. independent agreed to by ADB main provisions relate to the legal status of sector. Since then, the insurance and nonbank SECP to regulate and grant it the SECP, its structure, powers, functions, finance sectors and private pensions have also been company affairs adequate and financial arrangements. The SECP is passed on to SECP. However, SECP still has four and the securities management, also required to submit annual reports to regulatory divisions, each headed by a commissioner, market, and administrative, parliament within a specified period. An though there have been changes in the functions and submit to ADB an and financial important provision is the establishment of a structure of individual divisions. A new division, the organization plan autonomy, policy board consisting of five ex-officio professional service and policy division, has been for the new SECP. including members and four members from the private created to regulate and promote the development of October 1997.b discretion over its sector. The board, which is required to meet professional bodies and self-regulatory organizations budget and staff at least four times a year, advises the SECP (SROs) and recommend policy guidelines for the recruitment. Also, on various policy matters. The SECP has consideration of SECP and its policy board. strengthen SECP been empowered to administer the Securities Moreover, the enforcement division, previously a capacity to and Exchange Ordinance of 1969, Modaraba separate division, has been merged into the

enforce Companies (Floatation and Control) Corporate Law Division. The other two regulatory 1 Appendix regulations; Ordinance of 1980, and Companies divisions of SECP are the Securities Markets Division develop Ordinance of 1984. In August 1999, and the Specialized Companies Division. exchanges, regulation of the insurance sector was also brokers, and transferred to the SECP and the SECP Act The regulatory scope of the Securities Markets mutual funds; and was amended on 11 October 2000. Division has been extended to include commodity 27 provide an annual exchange and securitization; the latter used to be report on its under the Specialized Companies Division. regulatory functions. December 1998.c

28 First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) Appendix 1 The SECP has been vested with full The Specialized Companies Division has been administrative and financial powers and has assigned the regulation of the nonbanking finance control over revenues from different fees. companies (NBFCs) and the insurance industry, for

Staffing is based on the corporate plan and which separate departments have been set up. job descriptions prepared with the help of the consultants hired under technical assistance The Securities Markets Division has increasingly (TA) 1577-PAK(SF). The Act empowers the focused on enforcement function to check market SECP to undertake regulatory functions in abuse. The first-ever investigation of insider trading respect of all issues relating to the capital was in 2004; a local institution had to pay a penalty. market. The Act was amended in 2000 to Respondents in three cases of violations of the give the SECP regulatory jurisdiction over the takeover law also paid penalties. However, the insurance sector. The SECP has full penalty levied by SECP in a price manipulation case regulatory powers to ensure the smooth was abolished by the SECP appellate tribunal. functioning of stock exchanges and market intermediaries. As required under Section 25 of the SECP Act, SECP has been publishing annual reports on its activities The SECP has four commissioners and a and performance. The fifth annual report for FY2004 chairperson. Since obtaining financial was recently released. autonomy, the SECP has hired 67 professionals, 58 of whom have a background in business administration and accounting and eight have a legal background. The SECP prepared its first annual report for the year 2000 and is having the second report printed.

First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) II.A.9 The Cabinet II.B.6 In line with Substantially implemented (only Complied with. will approve key the enactment of takeover law is pending, recommendations recommendations though approved by the federal cabinet). SECP has started inspecting the books of accounts of the Corporate of the Corporate of brokers. Four brokers have so far been inspected Laws Review Laws Review The SECP has issued a number of capital and reports have been prepared. A number of Commission Commission and market-related rules/regulations/guidelines. brokers have also been penalized by SECP for pertaining to the the ADB-financed Some of these are: (i) Members’ Agents and defrauding investors. securities and TA,e the SECP will Traders (Eligibility Standards) Rules of 2001; corporate laws review and (ii) Stock Exchange Members (Inspection of The Listed Companies (Substantial Acquisition of that, among introduce Books and Record) Rules of 2001; (iii) Public Voting Shares and Take-Overs) Ordinance was others, empower regulations for Companies (Employees Stock Option promulgated by the Government on 29 October 2002. the SECP to disclosure by Scheme) Rules of 2001; (iv) Insider Trading However, SECP has not yet issued rules for this suspend brokers, listed companies, Guidelines of 2001; (v) Amendments to ordinance. impose penalties insider trading, Securities and Exchange Rules (Net Capital on certain carry-forward Balance Requirement); (vi) Share Transfer COT financing rules have been in place since 1997. defaulters, and system, corporate Agents, Underwriters, Balloters and However, COT financing is being phased out and the register registrars, registrar services, Consultants to the Issue Rules of 2001; number of securities eligible for COT has been balloters, and protection of (vii) Companies Share Capital (Variation in reduced from 365 to only 7. underwriters/ sub- minority Rights and Privileges) Rules of 2000; and underwriters. shareholders’ (viii) Brokers Agents Registration Rules of The Companies (Amendment) Ordinance of 2002 October 1997.b rights, inter- 2000. was promulgated on 26 October 2002. The key corporate amendments were: financing, The SECP has recently proposed 92 (i) The mandatory period for holding annual general investment amendments to the Companies Ordinance of meeting was reduced from 6 months to 4 months companies, 1984, which have been circulated to the from the close of the financial year. portfolio public for comment. The proposed (ii) Single-member companies were allowed to managers, public amendments seek to improve corporate operate. issues and governance and safeguard the interests of (iii) The maximum limit of 10% discount on issuance offerings, investors, and to develop the corporate of shares was removed. underwriters, and sector. The proposals are based on the (iv) The required quorum for a general meeting of a corporate recommendations of a committee that listed company was increased from three members to

takeovers and consulted with professional and trade bodies, 10 members representing not less than 25% of total 1 Appendix mergers. June the chamber of commerce, stock exchanges, voting power either of their own account or through 1999.c associations of investors, and individual proxies. experts. The proposed amendments have the (v) Members of stock exchanges were barred from following objectives: engaging in brokerage, and their spouses from 2 29 (i) To reduce the mandatory period for holding becoming directors of listed companies. annual general meetings from 6 months to 4 (vi) Permission was given to invest in associated months from the close of accounts. companies but only through a special resolution, (ii) To remove the restrictions on investment which must be approved by at least 75% of in associated companies. shareholders. (iii) To introduce the concept of a single- (vii) Listed companies must prepare accounts of

30 First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) Appendix 1 member company. subsidiaries and consolidated accounts for listed (iv) To increase the required quorum for a companies. general meeting of a listed company from

three members to 10 members representing The requirement for listed companies to prepare not less than 25% of total voting power either quarterly accounts remains in place. The companies of their own account or through proxies. must disclose through the stock exchange their (v) To make it mandatory for listed companies quarterly results within 1 month, their half-yearly to prepare accounts of subsidiaries and results within 2 months, and their annual results consolidated accounts in accordance with within 3 months from the close of period. International Accounting Standard 27.

The SECP has sought public opinion and discussed these proposals with legal, accounting, and business professionals.

Besides the above proposals, the SECP has made it mandatory for listed companies to disclose their quarterly accounts. At present, listed companies are required to file annual audited accounts and unaudited semiannual accounts.

Improve the II.A.10 Each stock II.B.7 Stock Governance of stock exchanges has been II.A.10 Complied with. corporate exchange will (i) exchanges will improved by the induction of external II.B.7 Complied with, but most prescribed governance of restructure and upgrade their directors, who now make up 40% of directors, measures were implemented by SECP rather than the stock expand its administration and the appointment of full-time professional the stock exchanges, as was required. exchanges governing board and staff and nonbroker chief executives at KSE and and by appointing a appropriately to, Lahore Stock Exchange (LSE). The recent The governance structures of the boards of stock reorganize significant among others, changes in the articles of association of KSE exchanges have changed. The number of directors them to proportion of improve seek to make the chief executive independent has been reduced from 18 to 10, equally divided improve their outside directors regulation, by requiring SECP approval before he or she between member (of exchange) directors and management who are monitoring, and can be appointed or removed. Directors are nonmember directors. Previously, on the 18-member and professionals and research and also required to delegate their powers to the board, 15 were member directors. Member directors operational nonbrokers (on development. In managing director of the exchange company are directly elected by stock exchange members efficiency. the basis of addition, the to ensure the separation of the management while nonmember directors are nominated from qualifications and stock exchanges of stock exchanges from the members, and various trade and professional bodies by SECP. The criteria agreed will adopt new (i) strengthen the office of the nonmember chief chairman is elected by the board from among the with the SECP) trade reporting executive. elected directors. The operational and administrative and nominees of rules, including activities of the exchange are managed by the the Policy Board penalties for KSE and LSE have taken steps to review managing director, who is the full-time chief executive of the SECP, and insider trading, their management structures. of the exchange and is appointed or removed only (ii) appoint a full- noncompliance, with the prior approval of SECP. time professional and off-market The KSE board of directors approved a

First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) and nonbroker deals; (ii) corporate plan in February 1999 to SECP issued guidelines on insider trading in 2001 chief executive inspection rules; strengthen the secretariat of the exchange and penalized a local institution in its first insider officer on the (iii) licensing under the managing director. The plan trading case in 2004. SECP has also started basis of standards for envisages the establishment of separate inspecting brokers’ books. The licensing standards for qualifications and traders and departments for market control and traders and agents are in part covered by SECP’s criteria agreed agents; (iv) listing surveillance, clearing and settlement, Brokers and Agents Registration Rules of 2001. with the SECP. requirements and information technology, internal audit, and SECP has also introduced a standardized account October 1997.b guidelines; and company affairs (which is also responsible for opening form, which brokers must have their clients (v) model listing and research). The corporate plan has fill out. contractual been substantially implemented. A full-time agreements for nonmember managing director has been KSE management has made progress in upgrading various hired. administration and staff to improve regulation, transactions. June monitoring, and research and development. Among 1999.c Since July 2001, LSE has taken steps to the measures taken by KSE management are: restructure its management according to a (i) System audits of brokers by an independent new organizational plan. More powers will be auditor. Since this measure was introduced in July delegated to strengthen the independence of 2004, 50 brokers have been audited and the reports the managing director in the administration of sent to SECP. the stock exchange. The new organizational (ii) Enforcement of restriction on short selling and plan is being implemented. A chief operating imposition of penalties in case of noncompliance. officer reporting directly to the managing (iii) Strict adherence to the collection of margins from director has been appointed. brokers. (iv) Monitoring of KSE-100 companies’ compliance Islamabad Stock Exchange (ISE) is yet to with the Code of Corporate Governance introduced in review its administrative structure. The post 2002. of chief executive has been advertised but (v) Tightening of margins against COT with the has not been filled so far. introduction in 2003 of security valuations based on 52 weeks’ average price. (vi) Upgrading and implementation of listing regulations. (vii) Reporting of all on-market trades to KSE, under Karachi Automated Trading System (KATS) rules.

However, reporting of client-to-client trades is not 1 Appendix mandatory.

31

32 First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) Appendix 1 SECP is pursuing the demutualization and integration of the stock exchanges. It set up an expert committee on 17 February 2004 to recommend an

implementation plan for the demutualization, integration, or transformation of the stock exchanges. The committee’s report was released by SECP in October 2004. The report recommended two models. The preferred model is a fully integrated, demutualized stock exchange uniting all three stock exchanges. Alternatively, a new national stock exchange may be established.

LSE and ISE have already announced plans for demutualization and integration. KSE formed its own committee comprising exchange members, which submitted, to the chairman of SECP on 20 April 2005 a draft preliminary report on the demutualization of KSE and a report on the valuation of the net worth of KSE by a firm of chartered accountants. In the report on demutualization, KSE also sought written policy replies from SECP on three issues related to integration with LSE and ISE: (i) integration versus competition, (ii) Electronic Communication Network and Automated Trading System, and (iii) number of brokers.

II.A.11 The SECP II.B.8 The Implemented. Complied with. is to take steps to Government will encourage grant a one-time The SECP and the Government have taken At OEM, 109 of the 200 KSE members, 60 of the 152 widening of exemption from policy measures to promote the LSE members, and 40 of the 121 ISE members are corporate capital gains tax corporatization of individual members of stock corporate entities. membership by leviable on a sole exchanges. The Government has granted the corporatization proprietor or a exemption from capital gains tax leviable on of sole proprietors partnership holding individual members on the transfer of or partnerships a stock exchange membership to a corporate entity. Tax that are members membership on the exemption was allowed for the period from 1 of stock transfer of such July 1998 to 30 July 1999 and from 1 July exchanges. membership to a 2000 to 30 July 2001. As a result, 92 of 200 September 1997.b corporate entity. members (133 are actually active) of KSE June 1998.c have become corporate entities and 134 members have registered with the SECP, while 37 of 151 LSE members have become

First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) corporate entities and 73 members have registered with the SECP. ISE has 33 corporate members out of its 102 members while 33 members are registered with the SECP.

II.A.12 Each stock II.B.9 The SECP Implemented. Complied with. exchange will and stock establish a exchanges will Each stock exchange has established The funding of clearing house and investor protection member establish an investor protection and clearinghouse funds of stock exchanges has been ahead of protection fund, investor protection protection (member protection) schemes, schedule because of increased allocations from rising and strengthen fund. June 1999.c although these are not funded. SECP stock markets and high turnover. the default and requires both funds to be fully funded by 30 disciplinary June 2007. At KSE, the Clearing House Protection Fund (CHPF) procedures and against member default was established in 1992 their enforcement. The funding requirements are phased. At while the Investor Protection Fund (IPF) was set up in September 1997.b least 50% must be funded immediately, 75% 1997 to protect small investors in case of members’ by 2003, and fully funded by 2007. default. Both funds are fully operational. As of 31 March 2005, CHPF had PRs592 million, including PRs386 million in separate bank accounts, and IPF had PRs592 million, PRs386 million of this in separate bank accounts. One fourth of the trade fees received by KSE go to these funds, which are managed under separate trust deeds.

At LSE and ISE, the funds are fully funded. As of June 2004, LSE had PRs185 million in its CHPF and PRs43 million in the IPF. At ISE, the CHPF has PRs15 million, and the IPF, PRs20 million.

1 Appendix

33

34 First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) Appendix 1 Improve the II.A.13 The SECP II.B.10 The SECP Implemented. II.A.13 Complied with. self-regulation legislation will will define minimum II.B.10 Not complied with. of stock include provisions criteria and Though the SECP Act of 1997 does not exchanges. for the promotion standards for specifically provide for promotion of self- Subsection 4(f) of Section 20 of the SECP Act of self-regulation conferring the regulation of the securities industry, the stock empowers SECP to promote and encourage self- of the securities status of a self- exchanges are working toward becoming regulatory organization structures for stock industry while regulatory self-regulatory organizations. The provisions exchanges and NBFCs. entrusting SECP organization on a of the Securities and Exchange Ordinance with powers to stock exchange empower the stock exchanges to prescribe The SECP Act of 1997 assumes the three stock penalize self- and support stock rules for regulating the market. The stock exchanges to be self-regulatory organizations. Yet regulatory exchanges in exchanges have established a system of SECP has not set minimum criteria for conferring organizations, developing their surveillance and are authorized to inspect self-regulatory organization status on a stock including self-regulatory brokers. The SECP treats the stock exchange. It has reservations about granting too revocation of capabilities.f June exchanges as frontline regulators while it much autonomy to regional, mutualized stock licenses for 1999.c remains an off-site regulator. exchanges. SECP is actively pursuing noncompliance demutualization of stock exchanges and meanwhile with defined keeping most regulatory functions to itself. criteria and standards. October 1997.b

Encourage II.A.14 The Mutual II.B.11 These Not implemented. II.A.14 Not complied with. other selected Fund Association associations will II.B.11 Not complied with. capital market of Pakistan develop into MUFAP and LAP have not developed into participants (MUFAP) and the self-regulatory self-regulatory organizations. They remain OEM could not independently verify that MUFAP and toward self- Leasing organizations in loosely organized and working mainly as LAP had indeed taken steps to develop their regulation. Association of accordance with representative bodies of their respective capabilities to oversee industry compliance with Pakistan (LAP) norms set by the industries. They must be properly organized prescribed standards and on-site supervision. will take steps to SECP to qualify for with a secretariat and qualified staff to develop their a self-regulatory perform self-regulatory organization SECP supports the self-regulatory organization status capabilities to organization functions. MUFAP has recently been licensed for MUFAP but believes that it cannot handle a self- oversee industry license. as a trade organization by the Ministry of regulatory organization functions just yet. SECP has compliance with June 1999.c Commerce (MOC), and is thus a quasi-legal asked MUFAP to introduce licensing criteria for fund prescribed entity. Standards for achieving a self- managers. MUFAP has indicated that it would need prudential regulatory organization status have not been 18 months to install such a licensing system. standards and announced by the SECP. Consultants hired perform on-site under TA 1577-PAK(SF) have not supervision. recommended granting self-regulatory September 1997.b organization status to LAP but made a positive recommendation for MUFAP.

First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) III. Improve and Modernize the Securities Market Infrastructure and Promote Its Integration Upgrade III.A.15 The stock III.B.12 Stock Implemented. Complied with. automated exchanges will exchanges, with trading adopt new and the support of the Automated trading started in Karachi for Implemented measures remain in place, i.e., all systems to compatible SECP, will fully certain scrips in September 1997 and the trading takes place through KATS and the open pave the way computerized operationalize system was extended to all scrips by May outcry system has been abandoned. for the screen-based harmonized and 1998, phasing out the open outcry system eventual trading systems automated trading completely. Automated trading was Stock exchanges continue to improve the automation integration of for selected for all scrips and introduced in LSE in August 1997 while ISE of trading systems. KSE has allowed remote-trading the national scrips. September completely phase has had automated trading since it began KATS terminals outside the KSE premises and is also market. 1997.b out the open operations in August 1992. implementing a plan for Internet trading. Some outcry method of brokers on their own are already offering Internet- securities trading. based trading services. June 1999.c

Promote III.A.16 The III.B.13 CDC will be Implemented. Complied with. development Government will fully of CDC. adopt legislation operationalized to The Central Depository Act of 1997 was At present 98% of all settlements on stock exchanges and regulations for introduce efficient promulgated on 7 June 1997 and regulations take place through CDC. As of 31 March 2005, CDC, including delivery, under the Act were issued on 25 June 1997. CDC’s main elements were: 453 participants and the features of settlement, and CDC became operational on 3 December account holders, 487 live securities, and 83 pledgee delivery-versus- transfer of 1997 starting with only one scrip. However, accounts. In addition, there are 581 corporate and payment system securities through a all listed securities were declared to be 21,900 individual investor accounts directly with provisions for computerized book- eligible securities for induction into CDC by maintained with CDC. To expand its geographical cash deposit entry system. June 23 June 1998. At present, CDC’s main coverage and promote investor accounts, CDC has account/exposure 1999.c elements are 373 account holders, 372 entered into an agreement for the opening of investor cap to ensure issuers, and 55 eligible pledgees. CDC accounts with Habib Bank Limited, now the largest fulfillment of started operations with custody services. It is bank in the private sector with a nationwide network obligations arising now offering delivery versus payment of more than 1,500 branches. CDC has also cut its out of services, which are covered by the CDC Act annual investor account fee from PRs1,500 to transactions, and and Rules. It also provides trustee services to PRs500. initiate an open and mutual fund.

operationalization CDC has implemented several contingency 1 Appendix of CDC. measures for smooth functioning. These measures September 1997.b include: CDC contingency site, online transaction backup, on-site and off-site tape back-up, and global terminal facility. 35 CDC is also working on a SECP directive to introduce global identification for clients. The deadline for this is November 2005.

36 First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) Appendix 1 Over time, CDC has also expanded its ambit of services. Aside from the core depository services, CDC also provides trustee and custodial services to

mutual funds. As of 31 March 2005, CDC was trustee to 15 closed-end mutual funds with net assets of PRs41 billion and custodian for two open-end mutual funds with net assets of PRs1.6 billion.

Promote the III.A.17 Stock III.B.14 An Partially implemented. Complied with. development exchanges and appropriate NCSS of a National CDC will develop and its supportive The NCSS has been developed with the help The National Clearing Company of Pakistan Limited Clearing and a proposal and legislation and of the consultants hired under TA 1577- (NCC) was incorporated in July 2001 and began Settlement agree on setting regulations will be PAK(SF). The National Clearing Company of operations in December 2001 with two securities. System up of the NCSS, developed and Pakistan has been incorporated (July 2001) However, by January 2004, all securities in the (NCSS). and cost sharing established to with paid-up capital of PRs35 million central depository system had been added to NCSS of the move toward contributed by the three stock exchanges. and all new additions to CDC since then have also development cost compliance with the The International Finance Corporation in been automatically included in NCSS. of its network. Group of Thirty Washington, DC, is also considering an September 1997.b recommendations equity participation for the company. The The present paid-up capital of NCC is PRs63.75 relating to project is being implemented in phases and million, held by the three stock exchanges (KSE securities and the balance order settlement system started PRs30 million, LSE PRs15 million, ISE PRs7.5 settlement. June functioning on 24 December 2001. million) and a development finance institution, Pak- 1999.c Kuwait Investment Company (PRs11.25 million). With these developments, six out of nine recommendations of the Group of Thirty were implemented. Recommendations implemented relate to trade comparison on T+1, full operationalization of central depository, netting system, delivery versus payment system, T+3 rolling settlement system , and use of International Organization of Securities Commission standards 7775 and 6166. Recommendations that have not been implemented relate to trade comparison for indirect participants, same-day funds convention, and securities lending through the NCSS.

First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) From the start, NCC operations have been handled by CDC under a facility management agreement. However, NCC is in the process of becoming independent, and only the management of its information technology functions will be retained with CDC. Some of the staff involved in managing NCC operations were transferred from CDC to NCC but the two companies still have the same chief executive.

NCC is complying with G-30 recommendations under the World Bank’s Financial Sector Adjustment Loan. NCC already complies with eight of the nine recommendations of G-30. The remaining one concerns the real time gross settlement system and the trade netting system provided for in the International Securities Service Association Pakistan Handbook, May 2003.

IV. Develop the Corporate Debt Market Promote IV.A.18 Market IV.B.15 Market Not implemented. IV.A.18 OEM could not independently verify development participants, participants will compliance status of this condition. of an over-the- including stock develop and Market participants, with whom CLA and IV.B.15 Partly complied with. counter (OTC) exchanges, establish an OTC consultants discussed the proposal, did not debt market. corporate market. June respond positively to it. Consultants who OEM could not independently verify whether a brokerage houses, 1999.c studied the subject under TA Loan 1577-PAK working group was indeed set up according to section and investment (SF) concluded that current trading volumes IV.A.18. companies, will in TFCs do not justify establishing a create a working mechanism to trade only in corporate debt A task force with members from SECP, SBP, and group that will set instruments. Pakistan Banks’ Association has been set up to make up an OTC market recommendations for the development of debt and to develop orderly, The establishment of an OTC market for both capital markets.

central, and Government securities and corporate debt 1 Appendix electronic screen- securities involves regulatory issues as Systems and procedures have been developed for based secondary Government securities are regulated by the the trading, clearing, and settlement of shares and trading in fixed- SBP while corporate debt securities are TFCs, or corporate bonds, in the OTC market, and income securities. regulated by the SECP. the legal framework is in place. The SECP expects September 1997.b the corporate debt market to develop once the trading 37 of OTC debt instruments starts.

38 First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) Appendix 1 IV.B.16 The SECP Implemented. Complied with. will introduce prudential The prudential guidelines for the use of OEM confirmed the PCR finding.

guidelines for the repurchase agreements in private debt use of repurchase securities have been issued by SBP. agreements in private debt securities. June 1999.c

V. Reform the Mutual Fund Industry Strengthen the V.A.19 SECP V.B.17 The SECP Implemented. V.A.19 Complied with. regulatory legislation will will strengthen the V.B.17 Partially complied with. framework for provide for the regulatory The Securities and Exchange Commission of the mutual regulation of all framework and Pakistan Act of 1997 makes the SECP The Companies Second Amendment Ordinance of fund industry. mutual funds, develop capabilities responsible for regulating the working of 2002 reinforces the regulatory authority of SECP over including the for the monitoring collective investment schemes, including unit NBFCs including asset management companies, public sector and inspection of trust (mutual fund) schemes (section 20[2]). investment advisers, and investment finance mutual funds. all mutual funds. As such, all mutual funds, whether in the companies. September 1997.b June 1999. c private or the public sector, are to be regulated by the SECP. NIT, which has NIT is licensed by SECP to undertake asset managed an open-end fund in the public management services. However, the functions of NIT sector since 1962, was registered with the are governed by the trust deed executed between SECP on 30 June 2000 under the Asset NIT and the National Bank of Pakistan on 12 Management Companies Rules although NIT November 1962, and the NIT Ordinance of 1965, is yet to submit its scheme to the SECP for under which NIT was set up. The regulatory authorization. The Investment Corporation of provisions of SECP apply to NIT to the extent that the Pakistan (ICP), the public sector NIT Ordinance does not address the specific issues. management company for 26 closed-end mutual funds since 1966, is yet to be So far SECP has relied on off-site monitoring of registered with the SECP. The SECP has mutual funds, and no on-site inspection of any mutual established a specialized companies division, fund manager has taken place. which regulates mutual funds. Steps taken to develop regulatory capability include inducting and training qualified staff and devising a monitoring system. Three officers of the division exclusively regulate mutual funds under the supervision of a director and an executive director.

First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) Strengthen the V.A.20 The SECP V.B.18 The SECP Among other provisions, the Investment Complied with. policy will amend the will further review Companies and Investment Advisor’s Rules framework for Investment and introduce as amended in January 1999: The Government has notified NBFC Rules of 2003, the mutual Advisors Rules of improvements in (i) increased the minimum paid-up capital the consolidated and updated set of rules for all funds industry. 1971, pertaining to the Investment requirement for investment companies NBFCs including asset management companies, the closed-end Advisors Rules of (closed-end mutual funds) from PRs20 million investment advisers, discount houses, housing funds with 1971 and in the to PRs100 million, and prescribed a minimum finance companies, investment finance companies, emphasis on Asset Management paid-up capital of PRs20 million for leasing companies, and venture capital companies. (i) increasing the Companies Rules investment advisers; These rules replaced the Leasing Companies minimum paid-up of 1995, with the (ii) permitted mutual funds to invest in unlisted (Establishment and Regulation) Rules of 2000, capital objective of securities (10%) and fixed-income securities Investment Companies and Investment Advisers requirement from updating the (20%); and Rules of 1971, Asset Management Companies Rules PRs20 million to industry standards. (iii) enabled investment advisers to manage of 1995, and Venture Capital Companies and Venture PRs100 million, June 1999.c more than one mutual fund. Capital Funds Rules of 2001, which have all been and introducing repealed along with a few of the finance division’s higher In 2001, a further set of amendments was notifications. professional notified to allow the flotation of sector-specific standards for funds and make it mandatory for mutual The NBFC Rules have set the following minimum appointment of funds to report net asset value to the stock capital requirements for the different types of fund managers; exchanges and the SECP. services: (ii) liberalizing investment (i) investment finance company: PRs300 million, requirements for (ii) leasing: PRs200 million, mutual funds so (iii) venture capital: PRs5 million, that they can (iv) discounting services: PRs200 million, invest in unlisted (v) investment advisory and asset management: and fixed-income PRs30 million, and securities to (vi) housing finance services: PRs100 million. facilitate diversification of The new rules allow closed-end funds to invest up to their portfolio; and 20% of the total investment portfolio in unlisted (iii) requiring government securities and secured debt securities

disclosure to with investment grade rating. Investment in a single 1 Appendix provide adequate company cannot be more than 10% of the funds’ information to unit capital or 10% of the company’s capital, whichever is holders. lower. Allocation to a single sector (according to the September 1997.b stock exchange classification) cannot exceed 25% of the funds’ net assets. However, according to the 39 rules, SECP could allow these investment conditions in view of the fund’s specific investment objectives.

40 First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) Appendix 1 V.B.19 The SECP Implemented. Complied with. will introduce a policy and The Asset Management Companies Rules of Six fixed-income mutual funds have been launched

regulatory 1995 have been amended to provide for the since 2002. framework for the establishment of sector-specific funds. As money market and such, money market and fixed-income The SECP is developing a regulatory framework for fixed-income securities funds can now be established. The real estate investment trusts in Pakistan. securities mutual SECP has already approved, in principle, a funds. June 1999.c fixed-income securities fund and has registered its asset management company. The scheme, including the trust deed, is being processed by the SECP.

Restructure V.A.21 The V.B.20 The Partially implemented. V.A.21 Partially complied with. the mutual Government will Government will V.B.20 Partially complied with. fund industry. (i) issue directives subcontract the Although the Government has taken certain to the NIT to management or measures to prepare for the privatization of Policy measures related to ICP have been withdraw the transfer the NIT, it is difficult to determine a definite time implemented while those related to NIT remain minimum majority of the frame for its privatization. largely unimplemented. guarantee price Government’s for NIT units as shareholding and The funds when transferred to the private Rather than privatizing ICP as an investment advisory soon as the net management of sector will no longer have the implicit company offering its shares for strategic sale, the asset value of NIT the asset guarantee of the Government. However, the Government initially privatized the management units is above this management Government had to issue a fresh letter of rights of the 26 ICP mutual funds in three lots, which level, (ii) initiate companies of NIT comfort to major investor institutions as these were acquired by two domestic institutions. The setting the NIT and ICP to found it difficult to make heavy provisions in management rights of lot A, comprising 12 mutual liabilities experienced fund the absence of such a letter. A positive funds with aggregate net asset value (NAV) of associated with managers. Prior development has been the decision of the PRs1,402 million at the time of privatization, were the minimum to this, the Government to allow some flexibility to NIT to sold for PRs175 million in September 2002. guarantee price, Government will trade stocks of state-owned enterprises. NIT Management rights of lot B, which comprised 25 (iii) allow NIT to fully settle the NIT has been allowed to sell shares of state- mutual funds with aggregate NAV of PRs1,713 million trade stocks of liabilities related owned enterprises in cases where the at the time of privatization, were sold for PRs303 strategic state- to the minimum Government’s direct or indirect holding million in October 2002. The third lot was the State owned guarantee price, exceeds 51%. Entity Mutual Fund of ICP with NAV of PRs2,669 enterprises, transfer the loan million at the time of sale of its management rights in (iv) issue portfolio of ICP to Preliminary steps have also been taken to April 2003 for PRs787 million. directives to ICP a suitable entity, privatize the management of NIT. to segregate the and provide Expressions of interest were invited through After privatizing its mutual funds, ICP surrendered its loan portfolio from voluntary the press in July 2001 for disinvestment of investment advisory license. ICP now has a its retirement 58% of shares held directly or indirectly by development finance institution status and is payment to the the Government. recovering loans that were extended earlier. It also excess work has its own equity portfolio worth about PRs2 billion. force. December Its present staff strength is 51, after two

First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) fund operations, 1998.c Eleven parties expressed interest. A rounds of retrenchment in 1997 and 2003. In 1997, its (v) assess the committee was formed to prepare a staff was reduced from 600 to 300 through a golden- level of staff statement of qualifications and recommend handshake scheme and another 267 people were rationalization criteria for prequalification. A statement of retired in 2003 and given handsome compensation required for the qualifications was sent to the 11 parties but packages. About 70% of ICP’s shareholding is now in two asset only four responded. The four are being private hands, after the privatization of nationalized management appraised for prequalification. Besides issues banks. The Government, with the consent of ICP’s companies, and related to the Government’s letter of comfort, shareholders, is planning a strategic sale of shares of (vi) agree on the other problems complicate the process of ICP itself. launching of the privatization. While 50% of the portfolio is ADB-financed TA invested in state-owned enterprises, the Measures related to NIT could not be implemented for Restructuring remaining portfolio is mostly illiquid. There because of various complexities: of Public Sector are concerns about volatile redemption (i) The minimum price guarantee to the three major Mutual Funds. pressure from institutional investors holding a holders of NIT units, accounting for 48% of the NIT October 1997.b substantial amount of units. Some legal fund now valued at about PRs70 billion, has not been issues such as the position of NIT’s trust withdrawn as that is likely to result in large deed vis-à-vis Asset Management redemptions though the price of NIT units is well Companies Rules also need to be resolved. above the minimum guarantee price. (ii) For the above reason, NIT has not initiated setting The Privatization Commission (PC) has its liabilities associated with the minimum guarantee invited a fresh submission of expressions of price. interest for NIT along with statements of (iii) Allowing NIT to trade (more specifically, sell) qualification, and prequalified five bidders to stocks of strategic state-owned enterprises (SOEs) carry out due diligence from 1 September would upset the privatization of these SOEs as NIT’s 2002. holdings constitute a significant part of these SOEs’ shares being offered by the Government in strategic As regards ICP, the federal cabinet decided sales. However, NIT has been allowed to sell shares in a meeting on 13 June 2001 to privatize ICP of SOEs in cases where the Government’s direct or funds and wind up the institution. indirect holding exceeds 51%. Consequently, the PC hired consultants to (iv) NIT has not undertaken staff rationalization but value the assets and identify legal and has put a freeze on further hiring. financial issues involved in the (v) TA 2865-PAKg and TA Loan 1577-PAK(SF)h did

implementation of the cabinet decision. As for not result in fully workable proposals on the 1 Appendix ICP, it was decided to sell its mutual funds restructuring of ICP and NIT. business in three lots rather than a single lot to increase competition. The PC invited The Government is pursuing an indigenously expressions of interest in March 2002 for the developed privatization structure for NIT, whereby the sale and transfer of management rights of lot fund shall be split into five equal units, and the 41 A of ICP mutual funds (comprising 12 of the management rights of two to three funds shall be 26 ICP funds). PC approved in July 2002 the transferred to the three major unit holders given a prequalification of nine parties (out of 16) that minimum price guarantee, which shall then be had submitted an expression of interest. The withdrawn. The management rights of remaining Cabinet Committee on Privatization in August funds shall be auctioned. The new acquirers of funds

42 First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) Appendix 1 2002 gave the final clearance for the PC to shall be required to maintain frozen shareholders in conduct the bidding process and the sale of SOEs until their privatization. NIT could later be lot A was finally closed on 11 October 2002 liquidated or sold to a new investor.

for PRs175 million. Further, in September 2002, the PC issued an invitation for the NIT has 12 equal shareholders. As with ICP, as a submission of expressions of interest and consequence of the privatization of banks, the major statements of qualification for the bidding of shareholders of NIT are now in the private sector. ICP lot B and conducted the bidding, similar However, according to the privatization agreements to that for lot A, on 24 October 2002. The sale of these banks, the Government retains the right to of lot B for PRs302.5 million has been enforce the restructuring and strategic sale of NIT. approved by the Cabinet Committee on Privatization.

Earlier, ICP had offered voluntary retirement to its staff, and 365 people have taken up the offer. The segregation of loan portfolio from fund operations has been complicated by the fact that ICP has borrowed more than PRs300 million from the fund.

VI. Develop the Leasing Industry Streamline the VI.A.22 Transfer VI.B.21 Strengthen Implemented. Complied with. regulatory the regulatory and the capability of the framework. supervisory SECP to regulate Regulatory and supervisory authority over The Companies Second Amendment Ordinance 2002 authority over the and monitor leasing companies was transferred from the reinforces the regulatory authority of SECP over leasing industry industry SBP to the CLA through an amendment to NBFCs including the leasing sector. from the SBP to compliance with the Banking Companies Ordinance in 1997. the CLA. February new capital After issuing the NBFC Rules of 2003, SECP issued 1997.b requirements and The SECP has established a Specialized a revised set of prudential regulations for NBFCs, prudential norms. Companies Division, which regulates NBFIs, including leasing companies. June 1999.c including leasing companies. Steps taken to upgrade the regulatory capability of the division include recruitment of qualified staff and development of a monitoring system. The regulatory framework for leasing companies was reviewed in consultation with the leasing industry and a new set of rules was notified on 25 September 2000. These rules also

First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) provide prudential norms to be followed by leasing companies such as limits on exposure, margin against facilities, and provisioning for nonperforming assets. To ensure compliance, periodic reporting requirements were prescribed. Out of nine statements required, one is monthly, three are quarterly, four are semiannual, and three are annual.

Strengthen the VI.A.23 The CLA VI.B.22 LAP, in Substantially implemented. VI.A.23 Complied with. capital base to will raise the collaboration with VI.B.22 Partially complied with. encourage the capital base the SECP, will In 1997, leasing companies were required to orderly growth requirements for strengthen the raise their minimum capital to PRs200 million Out of 19 leasing companies, three do not meet the of the industry. the leasing (i) industry by 30 October 1999. The last date for increased capital requirement but have submitted industry from standards for credit compliance was later extended to 30 June plans to SECP for increasing their capital to meet the PRs100 million administration 2001. Eighteen of 29 leasing companies have minimum capital requirement. ($2.5 million) to (origination and fully complied with this requirement. Leasing PRs200 million servicing), pricing, companies have found it difficult to raise their No substantive actions have been taken by the LAP ($5.0 million).i portfolio level of paid-up capital partly because of the to implement the measures specified in section September 1997.b management, and depressed stock market in the last few years, VI.B.22. However, most of these issues have been asset-liability which has limited their ability to raise addressed through the prudential regulations for management; and additional capital through rights issues. While NBFCs issued by SECP. (ii) lessor’s rights of pursuing its objective, the SECP has asked repossession, the noncomplying companies to submit plans including the right for meeting the regulatory requirements, of automatic which will be considered individually. This repossession. It will initiative has triggered mergers among the improve the leasing companies. adjudication of disputes through Although LAP has not taken any initiatives to legal procedures strengthen industry standards for credit

and amendment of administration or portfolio management, the 1 Appendix the substantive SECP has endeavored to address these laws, where issues through new leasing rules issued in necessary. June 2000. These rules were framed in 1999.c consultation with the industry. 43

44 First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) Appendix 1 In view of its experience, the SECP is proposing further amendments to the rules, which would be processed in consultation

with the industry. There has been a significant development in the procedure of adjudication in the case of default by a lessee. According to the Financial Institutions (Recovery of Finances) Ordinance of 2001, a financial institution is empowered to sell the secured property after serving three notices to the defaulting customer.

Tap alternate VI.A.24 LAP will VI.B.23 SECP will Implemented. Complied with. long-term prepare a concept develop and financing paper on introduce a legal After consultation with market participants, OEM confirmed the PCR finding. sources for the promoting asset and regulatory the SECP notified rules to facilitate and industry. securitization of framework for regulate the securitization of asset-backed the industry. issuance of asset- securities. The Companies (Asset Backed September 1997.b backed securities Securitization) Rules were notified in 1999. by the leasing Besides defining the terms “securitization,” industry. June “special-purpose vehicle,” and “originator,” 1999.c the rules lay down the conditions of registration and obligations of special- purpose vehicles. In Pakistan, securitization is still in a nascent stage. Though the Asset Backed Securitization Rules of 1999 were notified by SECP in December 1999, the banks/NBFIs that were keen to undertake such securitization transactions through special-purpose vehicles awaited final guidelines from SBP, their regulator. With the transfer of NBFI regulation to SECP, the guidelines are expected to be issued soon. SECP has recently approved the securitization deal for PRs1 billion for Paktel Ltd. against its present and future receivables.

First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) VII. Promote Contractual Savings Through Reforms of the Insurance Sector and Pension and Provident Fund Industry Strengthen VII.A.25 An action Implemented. Complied with. policy, plan for the reform legislative, and of the insurance OEM confirmed the PCR finding. regulatory sector, drawing on framework to the promote and recommendations ensure the of the Report of orderly growth the National of the Insurance insurance Reforms industry. Commission, 1993, and the report of the task force on reforms of the Insurance Act of 1938, will be submitted to ADB. October 1997.b

VII.A.26 The VII.B.24 The Implemented. VII.A.26 Complied with. Cabinet will Government will approve the prepare and adopt Although some preliminary work was done to VII.B.24 Complied with but with a modification, proposal for the the legislation for set up an independent regulatory body accepted by ADB, that SECP would assume the replacement of the an independent exclusively to regulate the insurance industry, regulatory functions envisaged for PIRA. Controller of PIRA and it was deemed desirable to empower SECP Insurance with an operationalize it, to regulate the insurance sector. ADB and the OEM confirmed the PCR finding. independent and and adopt the new Government took this decision after careful autonomous Insurance Act, thought and consideration of the views of At SECP, the Insurance Division headed by an Pakistan including international experts. The main executive director has been set up as part of Insurance amendments for considerations were: Specialized Companies Division at SECP. Insurance

Regulatory the compulsory (i) the relatively small size of the insurance Division administers the law of insurance that covers 1 Appendix Authority (PIRA) reinsurance and sector in Pakistan; licensing and supervision of insurers and other to promote the preferential (ii) the limited availability of qualified entities regulated under these laws. Insurance sound allotment personnel for regulatory bodies; Division is further divided into five wings: development of requirements for (iii) the comparative legal convenience of (i) actuarial services, the insurance the general adding the functions to an existing institution; (ii) life insurance prudential supervision, 45 industry, while insurance and (iii) non-life insurance prudential supervision, protecting the business (iv) cost-effectiveness. (iv) market conduct supervision, and interests of companies, (v) enforcement and prosecution. policyholders. solvency margins, Consequent to the policy decision, the SECP premium rates, Act of 1997 was amended on 11 October

46 First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) Appendix 1 PIRA, among and supportive 2000 to transfer the administration of the law Recently, SECP has appointed an insurance adviser others, will regulations for the of insurance from the Ministry of Commerce to assist the executive director of the Insurance (i) regulate all insurance to SECP. Under its own Act and the Division.

public and private industry. Insurance Ordinance of 2000, SECP has insurance December 1998.c enough power to effectively regulate the The oversight arrangement in the insurance industry companies; (ii) be insurance sector. Under the amended SECP remains unclear: SECP and MOC have issued their empowered to Act, SECP is responsible for monitoring and own rules but SECP has neither significant enforce the ensuring compliance by insurers, insurance enforcement powers nor the power to revoke regulations agents, and insurance surveyors with all licenses. The dichotomy has fueled uncertainty and pertaining to laws, rules, and regulations pertaining to weakened the ownership of the regulatory framework. licensing and de- insurance, as well as for promoting the From this perspective, the Government is considering licensing, organized development of the insurance transferring jurisdiction from MOC to MOF as an investment funds, market in Pakistan. MOC notified the new alternative regulatory arrangement. capital adequacy, insurance rules in August 2002. SECP has and solvency powers of investigation under the SECP Act. margins; For adjudication, the Insurance Ordinance (iii) undertake provides for a small disputes resolution inspection and committee, insurance tribunals, and an investigation of insurance ombudsman. SECP has formed an insurance insurance division under an executive companies, director. Seven officers and 15 supporting brokers, agents, staff now work in the division. and intermediaries; and (iv) adjudicate disputes between the insured and the insurance companies. October 1997.b

Adopt more VII.A.27 Cabinet VII.B.25 PIRA will Implemented. Complied with. stringent approval will be (i) assess financial sought to raise the compliance of The Insurance Ordinance of 2000 prescribes OEM confirmed the PCR finding. standards for (i) minimum paid- insurance minimum paid-up capital requirements as well the insurance up capital companies with as solvency margins for both life and general The solvency margin is being used as proxy for industry. requirement for these new financial insurance companies. Life insurance introducing risk-based capitalization requirement. domestic life standards; companies are required to raise their paid-up insurance (ii) identify further capital to PRs100 million by the end of 2002 SECP does not have clear de-licensing powers under companies from improvements in and to PRs150 million by the end of 2004. the Insurance Ordinance of 2000. But it can apply to PRs30 million to the regulatory General insurance companies are required to court for the winding up of an insurance company if PRs100 million framework, increase their paid-up capital to PRs50 million the company remains noncompliant for more than 3 ($2.5 million) and including standards by the end of 2002 and to PRs80 million by months.

First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) for domestic for risk-based the end of 2004. As regards the solvency SECP has recently issued the first license for general insurance capitalization, as margin, the Insurance Ordinance defines it insurance brokerage services. companies from well as redefinition and empowers the SECP to prescribe the PRs25 million to of the solvency margin. The rules that have been drafted PRs40 million ($1 margin; (iii) de- under the Insurance Ordinance of 2000 million);j and license market propose specific solvency margins. (ii) raise the operators that fail solvency margin to comply or (defined as assets indulge in minus liabilities) malpractice; and from PRs0.5 (iv) issue million (or 10% of regulations for net premium) to brokerage houses PRs2.5 million. for general October 1997.b insurance. June 1999.c

Take steps to VIII.A.28 The VIII.B.26 PIRA will Partially implemented. VIII.A.28 OEM could not independently verify if improve Controller of reconstitute and this condition was met. professional Insurance will operationalize the The Insurance Ordinance, and its VIII. B.26 Partially complied with. and ethical define standards Insurance Claim comprehensive rules, prescribe professional standards of for various market Settlement Board and ethical standards for insurers as well as No substantive upgrading of Pakistan Insurance the industry. participants in the with powers to other intermediaries in the insurance industry. Institute has taken place. Only the state-owned insurance execute its own The Insurance Ordinance also provides for a insurance companies provide funding for the institute; industry, including decree and hold constitution and procedure for the working of private sector companies do not. the qualifications, regular hearings; tribunals for the settlement of claims. obligations, and and seek In place of operationalizing Insurance Claim duties of agents collaboration from No steps have been taken to upgrade the Settlement Board, MOC is implementing the following and brokers, and the insurance Pakistan Insurance Institute and there are no measures: the Insurance industry and satisfactory arrangements in the country for (i) Establishing the Insurance Ombudsman. The Association of Insurance the education and training of insurance secretariat and infrastructure shall be at SECP but Pakistan will Association of professionals in the insurance sector. The expenses shall be met by contributions from

prepare a Pakistan to absence of a well-established education and insurance companies. 1 Appendix proposal to upgrade Pakistan training institution for insurance is being (ii) Setting up the Small Dispute Settlement upgrade the Insurance Institute increasingly felt by the insurance industry, Committee to handle disputes of up to PRs0.5 million. Pakistan to provide special which is facing difficulties in recruiting (iii) Setting up insurance appellate tribunals headed Insurance training courses for qualified personnel and in upgrading the skills by district and session judges in main cities. A Institute. October brokers and and knowledge of employees through summary in this regard has been with the Prime 47 1997.b agents, surveyors, training. Minister for the past 2–3 months. loss adjustors, and underwriters, and to play a key role in increasing public

48 First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) Appendix 1 awareness regarding insurance. June c 1999.

Restructure VIII.A.29 The VIII.B.27 The Implemented. Complied with. and divest Government, with Government will public sector the support of restructure or Significant steps have been taken to After corporatization, PIC was renamed PRCL. Its insurance ADB-financed TA divest PIC and restructure PIC and NIC, as a prerequisite for paid-up capital was raised from PRs50 million to companies. 2866-PAK for NIC in accordance privatization. PIC was incorporated as a PRs450 million in November 2002. The compulsory Reform of the with the public limited company on 30 March 2000 as cession available to PRCL from domestic insurance Insurance recommendations the Pakistan Reinsurance Company Limited company was removed in January 2005 and a Industry, will of the studies. (PRCL) with a paid-up capital of PRs50 phased withdrawal of right of first refusal is also in the initiate studies of June 1999.c million. NlC of Pakistan was incorporated as cards. PRCL hired a domestic consultant for the Pakistan a public limited company on 31 March 2000 corporate restructuring, who recommended reducing Insurance with a paid-up capital of PRs100 million. The the head count from 300 to 160. PRCL formalized a Corporation (PIC) Government, which has substantial voluntary separation scheme, but the scheme has not and the National shareholdings in both companies, has been implemented. Insurance nominated private sector professionals for Company Limited their boards of directors. These companies, Under private sector management, NIC has seen its (NIC) to review working under the discipline of the business grow despite a shrinking captive market due their role in the Companies Ordinance, are also being to the ongoing privatization of SOEs. The company’s changing registered under the Insurance Ordinance. gross premium increased from PRs1.9 billion in 1999 environment and to PRs4.0 billion in 2004. In line with the explore options for management consultant’s recommendations for a improving reduction in staff strength, NIC reduced its workforce corporate from 600 to 400 in 2002 through a voluntary governance, and separation scheme. To develop its human resources, the restructuring/ NIC has established an in-house learning center divestment of while also sending staff to Pakistan Insurance these companies. Institute for training. October 1997.b With the introduction of the Insurance Ordinance and the amended SECP Act, both PRCL and NIC have been regulated by the SECP.

First Tranche- Second Tranche- Program Program Measures Measuresa Nov 1996 to 1998 to Compliance Status Compliance Status and Follow-On Measures Objective Oct 1997 Dec 1999 as per Program Completion Report (PCR) as per Operations Evaluation Mission (OEM) Reform VIII.A.30 A VIII.B.28 The Implemented. Complied with. pension and working group will Government, in provident be set up to collaboration with The Government formed a working group to SECP issued draft Voluntary Pension System Rules funds. implement a study ADB, will develop assist the consultants under the ADB TA for in November 2004. The rules mandate the division of financed by the plans for public and the reform of pension and provident funds. a pension fund into equity and debt sub-funds, with ADB TA 2867- private pension and allocations to each sub-fund being linked to the age PAK for Reform of provident funds, The finance minister, in his budget speech on group of members of the pension fund. For example, Pension and drawing on the 18 June 2001, announced that the in the 18–30 years age group, the permissible ranges Provident Funds recommendations Government would develop a framework for for asset allocations are 10–40% for debt sub-funds with the objective of the TA study. promoting the growth of pension funds. He and 60–90% for equity sub-funds. For those 60 years of developing a June 1999.c also announced a tax rebate on investments and above, the permissible ranges are 90–100% for reform proposal in an approved pension fund. The SECP debt sub-funds and 0–10% for equity sub-funds. for improving the prepared a comprehensive proposal in July coverage of the 2001 and submitted it to the Ministry of social security Finance for approval. system and financial The SECP has designed a personal pension management of system aimed at promoting the establishment pension and of individually capitalized pension savings provident funds. accounts managed by private sector September 1997.b professional managers. a All bold conditions were tied to the release of the second tranche. b At approval of the Loan, ADB and the Government considered the program measures to have been implemented in this month and year. c At approval of the Loan, ADB and the Government considered this month and year to be target for implementation of the program measures. d Enactment of legislation was a condition for loan effectiveness. e ADB. 1997. Report and Recommendation of the President to the Board of Directors on Proposed Loans to Pakistan for the Capacity Enhancement of the Securities Market Development Program. (TA Loan 1577-PAK[SF], for $5 million, approved on 6 November 1997). Manila. f These would include capabilities to (i) undertake on-site examinations of brokerage firms to ensure compliance with securities legislation, and rules and regulations of stock exchanges; (ii) ensure audit of members’ accounts; (iii) monitor compliance with prudential norms; (iv) introduce continuous, automated surveillance of security transactions; (v) provide arbitration and dispute resolution mechanisms; and (vi) develop programs to improve professional and ethical standards in the industry, as well as to educate and protect investors. g ADB. Technical Assistance to the Islamic Republic of Pakistan for Restructuring of Public Sector Mutual Funds. Manila (TA 2865-PAK, for $800,000, approved on 1 Appendix 15 September 1997). h Main text, footnote 3. i The new companies were to meet these requirements upfront, while existing companies would have 3 years to comply with the new standards. j The new companies were to meet these requirements upfront, while existing companies would have 3 years to meet the requirements. 4 49 Source: Operations Evaluation Mission.

50 Appendix 2

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

I. BACKGROUND

A. Rationale

1. In conjunction with the Capital Market Development Program (CMDP), the Government of Pakistan requested the Asian Development Bank (ADB) for technical assistance (TA) to strengthen the regulatory framework and basic market infrastructure of the capital market to facilitate its orderly and sustainable growth. In response, ADB approved TA Loan 1577- PAK(SF): Capacity Enhancement of the Securities Market, for $5 million equivalent, from ADB Special Fund resources on 6 November 1997.

B. Objective and Scope

2. The objectives of the TA loan were to support the: (i) institutional strengthening of the Securities and Exchange Commission of Pakistan (SECP) (component I), (ii) strengthening of the self-regulatory mechanism for key market participants (component II), (iii) establishment of the National Clearing and Settlement System (NCSS) (component III), and (iv) establishment of an over-the-counter (OTC) market to develop the secondary market (component IV). The fifth objective, i.e., to support the privatization of mutual funds run by state-owned companies (component V), was added in the course of implementation (in January 2000). The TA loan was to finance (i) consulting services in the form of studies, technical advice, master planning, and training; and (ii) procurement of computer hardware and software.

C. Financing Plan and Implementation Arrangement

3. The total cost of the TA was estimated at $7.0 million equivalent, comprising foreign exchange costs of $5.6 million and local currency costs of $1.4 million equivalent. ADB was to finance $5.0 million equivalent, comprising $4.3 million in foreign exchange costs and $0.7 million equivalent in local currency costs. The TA included a provision for $2.5 million for computer hardware and software for NCSS and the OTC market. ADB was to finance only a part of this cost while the rest was to be funded by the stock exchanges, Central Depository Company of Pakistan (CDC), and other market participants. The Government was to on-lend the TA loan proceeds on commercial terms to CDC for the establishment of NCSS, and to the stock exchanges for the establishment of the OTC market. The difference in the interest rates was to be transferred to SECP to finance its institutional development.

4. The Executing Agency of this TA loan was the Ministry of Finance. The Implementing Agency was SECP, which was to provide the necessary office space, counterpart staff, and other services to consultants. SECP was responsible for overseeing the implementation of components I and II. A technical group of the Inter–Stock Exchange Committee (including CDC) was to oversee component III. Karachi Stock Exchange, in collaboration with the other two stock exchanges and lead financial institutions, was to manage and supervise component IV. These institutions were envisaged to collaborate in establishing a legal entity to set up an OTC market. The TA project was planned to begin by March 1998 and to be completed by August 1999.

5. The TA required 135 person-months of consulting services (38 international and 97 domestic). The consulting team was to comprise five international consultants: (i) an SECP/stock exchange market expert/team leader (5 person-months for component I, and 1

Appendix 2 51 person-month for component II), (ii) a clearing and settlement expert (12 person-months for component III), (iii) a systems expert (6 person-months each for components III and IV), and (iv) a debt market expert (8 person-months for component IV). The international consultants were to be assisted by five domestic consultants: (i) a stock exchange expert (5 person-months each for components I and II), (ii) a legal expert (2 person-months for component II, and 6 person- months each for components III and IV), (iii) a management information system (MIS) expert (2 person-months for component II, and 6 person-months for component III), (iv) a systems specialist (18 person-months for component III, and 12 person-months for component IV), and (v) a computer programmer (12 person-months each for components III and IV).

D. Completion and Self-Evaluation

6. The TA loan closed on 30 July 2002 (after four extensions), 19 months later than initially planned. The program completion report (PCR) on the CMDP1 and this TA loan was circulated in November 2002. The PCR offered little information on the implementation performance, outputs, and outcome of this TA loan, and did not give an overall rating.

II. EVALUATION OF FORMULATION AND DESIGN

7. The TA objectives were consistent with the priority given by the Government to the development of capital market institutions and infrastructure. Before approving this TA loan (in June–September 1997), ADB also approved (i) TA 2812-PAK: Interest Rate Management of National Saving Schemes, (ii) TA 2825-PAK: Capital Market and Insurance Law Reform, (iii) TA 2865-PAK: Restructuring of Public Sector Mutual Funds, (iv) TA 2866-PAK: Reform of Insurance Industry, and (v) TA 2867-PAK: Reform of Pension and Provident Funds.2 All these TAs were aimed at supporting the CMDP implementation. The implicit agenda of the TA loan was to support the areas that were not covered under the stand-alone TAs. In effect, the residual issues found their place in the TA loan in the later stage of CMDP implementation. Accordingly, CMDP processing missions had less discussion with the relevant agencies on the design of this TA loan relative to the stand-alone TAs, and the report and recommendation of the President did not give detailed terms of reference (TOR) for the OTC debt market component. Moreover, the envisioned fast-track implementation schedule was overly ambitious considering that the SECP was a new entity that lacked sufficient absorption capacity and had no experience in implementing a TA loan. The Operations Evaluation Mission (OEM) considered these to be reflective of weakness in appraisal.

8. The OEM considered the inclusion of the original four components to be appropriate since they complemented the CMDP. The SECP and other relevant agencies were fully committed to CMDP measures supported under components I and III. However, their commitment to CMDP measures related to components II and IV was questionable. In fact, SECP did not actively pursue the CMDP measures related to these two components, nor did it pay much attention to components II and IV during implementation.

9. The inclusion of the fifth component pointed up the discouraging result of TA 2865-PAK: Restructuring of Public Sector Mutual Funds. This TA was to support the restructuring of the National Investment Trust Limited (NIT) and Investment Corporation of Pakistan (ICP), and to prepare a strategy and action plan for privatizing their asset management business and transferring management control to strategic investor(s). The consulting team for this TA

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

52 Appendix 2 recommended: (i) the sale of a single mutual fund management contract covering all mutual funds managed by ICP, and (ii) the auctioning of NIT’s unit trust business in the form of a new asset management company. In both cases, the sale to foreign fund managers experienced in mutual funds management in a more stringent regulatory environment was recommended to improve mutual fund management standards in Pakistan. However, the financial adviser engaged by the Privatization Commission later concluded that this recommendation was impractical, as foreign fund managers indicated little interest in taking strategic stakes in ICP and NIT. Therefore, this TA contributed little to the formulation of the privatization strategy for ICP and NIT (i.e., the sale of management rights rather than asset sales), which was adopted in June 1999 by the Privatization Commission. To implement this strategy, the Privatization Commission requested ADB to consider a fast-track small-scale TA to finance the services of a financial adviser or alternatively to reallocate funds under TA Loan 1577-PAK(SF). ADB agreed to add the fifth component under the TA loan in January 2000. The OEM considered the inclusion of this component, albeit as an afterthought, justifiable given the need to expedite the implementation of the CMDP measures concerned.

III. EVALUATION OF IMPLEMENTATION AND OUTPUTS

10. The agreement with the consulting firm was signed in February 1999, about 11 months later than planned because of administrative/procedural delays in selecting consultants and finalizing the contract on the recipient’s side. The inception meeting for the TA loan was held in May 1999. The TA loan closed in July 2002, about 19 months later than planned. The delay in TA implementation, which was originally planned for June 1999, impeded the Government’s compliance with conditions for the release of the second tranche of the CMDP loan.

11. The lack of verifiable TA outputs was a serious constraint on the evaluation of this TA loan. Neither ADB nor SECP stored the consultants’ reports in their record sections. After a review of TA loan files, the OEM surmised that the consulting team did not compile their outputs in one final report but instead submitted several reports at different times. The TA loan files included some of these reports in draft or final form.

12. Through seven review missions 3 and regular communication with SECP and the consulting team, ADB monitored the implementation of the TA loan. Despite the extensive monitoring, gaps in the perception of work procedures and outputs, especially for component I, persisted between the SECP and the consulting team during implementation. According to the OEM, this result could have been due in part to the consultants’ inadequate understanding of local contexts and the client orientation. An ADB officer raised the concern that a change in SECP management during implementation had also changed SECP’s expectations from the TA loan, probably worsening the confusion in the consulting team. Against this background, the SECP officials who interacted with the consulting team understandably did not positively assess the overall performance of the consulting team.

13. Table A2 gives the cost breakdown of the TA loan by type of spending. Actual consulting expenses exceeded the projected amount presumably because of the inclusion of the fifth component. The OEM could not verify the reason for the less-than-projected expenses for equipment.

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

Appendix 2 53

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

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

A. Component I: Institutional Strengthening of SECP

14. The consulting team, in line with the TOR, (i) drafted SECP’s corporate plan; (ii) developed a MIS; and (iii) submitted reports on regulatory issues related to (a) disclosure by listed companies, (b) intercorporate financing, (c) issues and offerings, (d) underwriters, and (e) takeover bids. The correspondence suggests that the consultant’s output on the corporate plan came close to the SECP’s expectation. The OEM could not obtain enough feedback from SECP to assess the TA loan’s contribution to the MIS. The SECP noted that the reports on regulatory issues were either not delivered in time for effective use or deficient in quality. The OEM could not obtain any of these reports for independent evaluation.

15. In July 2001, ADB endorsed SECP’s request for (i) the reallocation of $0.25 million from the remaining fund to support studies on mutual fund industry regulations and the training of SECP staff on this subject, and (ii) the associated extension of the TA loan closing date. In November 2001, ADB approved a further allocation of the TA loan to support the holding of an insurance training seminar, and another extension of the closing date. Neither the seminar materials nor the participants’ feedback/evaluation forms were available to the OEM. Thus, the OEM could not independently evaluate the quality of these seminars. The feedback from the interviewees of the OEM suggested the mixed quality of the study and seminars.

B. Component II: Strengthening of the Self-Regulatory Mechanism for Key Market Participants

16. At the start of the TA loan, the SECP noted, “this component has not been well thought out as it should have been until now.”4 A review of the correspondence confirmed that the consulting team submitted the report on the framework for self-regulation of the stock exchanges, the Leasing Association of Pakistan, and the Mutual Fund Association of Pakistan. But the OEM could neither obtain a copy of this report nor verify the SECP’s response to it.5 This report was the only output of this component. The PCR noted that this report recommended the granting of self-regulatory organization status to the Mutual Fund Association of Pakistan but not to the Leasing Association of Pakistan.

4 Back-to-office report of the inception mission dated 28 May 1999. 5 According to the PCR of the CMDP, the consulting team assessed the actual implementation of the self-regulatory framework to be premature given the level of capital market development in Pakistan.

54 Appendix 2

C. Component III: Establishment of the National Clearing and Settlement System

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

18. In line with the TOR, the consulting team developed a master implementation plan for NCSS, prepared relevant regulations and procedures, and identified the required computer hardware and software. These outputs were largely to the expectation of the NCC. However, the effort was wasted, as SECP turned down the CNS system in the final phase of pre- launching. SECP explained that the CNS system developed by the consulting team did not fully consider leveraged trading and that the SECP preferred a balance order system (BOS), which had a simple mechanism of matching orders. 6 NCC therefore had to redo the system development and other works associated with the adoption of BOS, and both NCC and SECP later admitted that the TA loan was not used efficiently. Nevertheless, NCC acknowledged having learned through interactions with the consultants and experience in developing the BOS on its own. Moreover, NCC also acknowledged the consultants’ contribution in enhancing the awareness of market participants of the significance of the NCSS.

D. Component IV: Establishment of an OTC Market to Develop the Secondary Market

19. At the inception meeting of May 1999, the ADB mission stated, “the OTC component of the CMDP would take time to develop and there were no conditionalities associated with this (component).”7 This is representative of the skepticism within the ADB mission as well as the SECP about the feasibility of the program measure (not tied to tranche release) that envisaged the establishment of an OTC debt market by June 1999. During the inception meeting, it was agreed that as a first step, the consulting team would prepare a study paper on how best to encourage the development of a secondary debt market. A review of the correspondence confirmed that the consulting team submitted the study paper, which concluded that the development of an OTC debt market was premature given the reality in Pakistan. Hence, the other expected outputs related to an OTC market, e.g., a master implementation plan, operating software and hardware, and relevant regulations, were not pursued. The OEM could neither obtain a copy of this report nor verify the SECP’s response. Also, the OEM could not verify the actual cost of this component. As noted earlier, the TOR for this component, although not detailed in the report and recommendation of the President, assumed 44 person-months of consultant involvement. The OEM considered this inappropriate.

6 The OEM believed that further study by an outside expert in this field would be needed to assess the appropriateness of the decision of SECP. 7 Back-to-office report of the inception mission dated 28 May 1999.

Appendix 2 55

E. Component V: Privatization of Mutual Funds Run by State-Owned Companies

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

IV. ACHIEVEMENT OF TECHNICAL ASSISTANCE PURPOSE

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

V. OVERALL ASSESSMENT

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

23. The OEM assessed the TA loan as less efficacious because of the following observations: (i) the delay in implementation impeded timely compliance with the relevant conditions of the CMDP for the release of the second tranche, and (ii) many outputs and recommendations were underutilized or not utilized at all by the recipient agencies.

24. The OEM assessed the TA loan inefficient in view of its (i) cost-ineffective use of loan funds; (ii) underutilization of the allocated loan funds; and (iii) inappropriate storing of consultant outputs both in recipient institutions and in ADB, impeding their potential use at a later stage and in post-evaluation undertakings.

25. The OEM assessed the sustainability of the TA loan as likely, since SECP and NCC are likely to secure human and financial resources to maintain the TA loan’s outcomes though the outcomes are highly limited. The OEM assessed the institutional development and other impacts of the TA loan as moderate, noting its contribution to enhancing market participants’ understanding of the NCSS.

26. On the basis of the above, the overall rating of the TA loan is partly successful.

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

STATISTICAL DATA 56 Table A3.1: Stock Market Dataa

Average Initial Public Offerings Appendix 3 Annual Daily IPO Market Capitalization Turnover Volume No. of Amount Subscriptions Fiscal Year (PRs (PRs (million Listed (PRs (PRs Endingb KSE-100 billion) % of GDPc billion) shares) Companies Stocks million) million) 1994 2331 406 25.9 — 6.5 676 55 3,208 40,739 1995 1607 486 25.8 — 9.5 742 59 11,044 25,971 1996 1703 371 17.6 — 22.9 783 37 3,434 9,949 1997 1566 492 20.3 — 33.9 782 8 1,047 282 1998 880 258 9.6 — 63.8 778 2 200 28 1999 1055 288 9.8 — 103.4 769 0 0 0 2000 1521 394 10.4 — 192.7 762 3 542 810 2001 1366 342 8.2 1,073 118.2 759 2 300 1,075 2002 1770 412 9.3 805 119.7 725 5 1,418 1,134 2003 3402 756 15.7 2,266 214.4 702 2 311 1,193 2004 5279 1,422 26.0 5,538 387.1 675 10 10,466 46,470 2005 7770 2,144 34.8 — — 660 12 13,472 56,822 (up to March) — = not available, GDP = gross domestic product, IPO = initial public offering, KSE = Karachi Stock Exchange, NA = not available, PRs = Pakistan rupees. a Karachi Stock Exchange only. b Except where indicated, the year-end is June. c Government rebased GDP in FY2004 with retrospective effect from FY2000. The revised FY2000 GDP was higher by 20.5%. Sources: Karachi Stock Exchange for the stock market data and Economic Survey of the Ministry of Finance for the GDP data.

Table A3.2: Corporate Debt Capital Market Dataa

Outstanding TFCs Average Treasury Number of Issue Size IPO Amount Total Value % of Bank Bank Creditc Bill Yieldd Fiscal Year Endingb TFC Issues (PRs million) (PRs million) Number (PRs million) Credit (PRs million) (%) 1994 — — — — — — 397,000 12.4 1995 1 210 100 1 210 0.0 473,000 11.6 1996 2 750 175 3 960 0.2 537,000 13.2 1997 1 1,000 250 4 1,960 0.3 627,000 15.8 1998 1 250 50 5 2,210 0.3 713,000 15.3 1999 4 1,750 650 8 3,710 0.5 794,000 12.7 2000 4 1,100 245 11 4,600 0.5 876,000 8.9 2001 10 5,530 1,235 20 9,630 1.0 946,000 10.3 2002 17 9,710 2,255 34 17,785 1.8 972,000 8.3 2003 21 10,399 2,025 53 27,834 2.6 1,052,000 4.2 2004 3 2,000 400 49 27,209 2.0 1,358,000 1.5 2005 3 3,725 775 50 27,709 1.6 1,688,000 3.5 (up to March) — = not available, PRs = Pakistan rupees, TFC = term finance certificates. a Term finance certificates listed on Karachi Stock Exchange. b Except where indicated, the year-end is June. c Credit to private sector only. d Yearly average of 6-month treasury bill cutoff yields. Sources: Karachi Stock Exchange for the TFC data and State Bank of Pakistan for the bank credit and treasury bill yields.

Appendix 3 Appendix 5 57

Table A3.3: Mutual Fund Industry 58

Number of Mutual Funds Launched Size of Mutual Funds (PRs million) Fiscal Year Open- Closed- % of Bank Bank Deposits Appendix 3 Endinga Open-End Closed-End Total End End Total Deposits (PRs million) 1994 0 4 4 —— —— 586,000

1995 0 8 8 32,927 — — — 709,000 1996 0 2 2 34,130 — — — 822,000 1997 1 0 1 25,042 7,454 32,4963.33 976,000 1998 0 0 0 12,152 3,957 16,109 1.47 1,093,000 1999 0 0 0 13,913 4,530 18,443 1.56 1,179,000 2000 0 0 0 19,117 4,002 23,119 1.92 1,201,000 2001 0 0 0 16,811 4,127 20,938 1.60 1,310,000 2002 2 0 2 18,953 4,540 23,493 1.58 1,489,000 2003 5 0 5 39,637 11,122 50,759 2.90 1,753,000 2004 4 3 7 67,532 25,090 92,622 4.32 2,145,000 2005 1 4 5 88,161 40,608 128,769 5.47 2,352,000 (up to March) — = not available, PRs = Pakistan rupees. a Except where indicated, the year-end is June. Sources: State Bank of Pakistan, Karachi Stock Exchange, and Mutual Funds’ Financial Statements.

Table A3.4: Insurance Sector (PRs million)

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

A. General Insurance 1. Number of companies 57 63 62 62 62 58 58 52 52 49 52 2. Gross premium collected 6,736 7,964 9,140 9,496 10,306 11,014 12,323 13,149 15,284 19,577 22,039

B. Life Insurance 1. State Life Insurance Corporation a. Number of policies 300,492 439,510 336,220 277,158 225,260 186,177 135,942 132,226 149,739 183,595 222,968 b. Gross premium collected 4,4280 5,851 6,255 5,661 5,507 5,323 5,317 5,482 5,879 6,900 8,208

2. Other Companies a. Number of companies 2 3 4 4 4 4 4 4 4 4 4 b. Number of policyholders 10,547 15,593 24,690 30,514 34,423 41,432 50,650 60,353 72,555 90,028 110,130 c. Gross premium collected 91 155 242 333 489 675 980 1,352 1,919 3,110 3,569

3. Total Life Insurance a. Number of companies 3 4 5 5 5 5 5 5 5 5 5 b. Gross premium collected 4,519 6,006 6,497 5,994 5,996 5,998 6,297 6,834 7,798 10,010 11,777

PRs = Pakistan rupees. a As of end-December. Sources: Ministry of Commerce and Ministry of Finance. Appendix 3 Appendix 5 59

Table A3.5: Leasing Sector Data 60 (PRs million)

Item 1994a 1995a 1996a 1997a 1998a 1999a 2000a 2001a 2002a 2003a 2004a Appendix 3 Number of Companies 24 27 30 35 33 32 32 29 30 28 24 Investment in Lease Finance 13,520 15,316 20,363 25,559 29,164 29,039 30,281 36,680 39,886 35,677 44,429

Investments 1,084 1,4841,768 2,590 2,724 2,664 3,1623,646 11,143 13,041 15,243 Borrowings 5,288 4,2968,076 10,319 10,243 23,765 25,74031,472 37,109 36,285 48,872 Revenues 2,463 2,5224,090 5,046 5,315 5,528 5,7046,401 7,692 7,273 7,048 Net Profit 695 517 922 906 610 451 573 398 192 1,211 1,843 Total Assets — — — — — 35,579 39,147 45,222 58,831 62,637 74,403 — = not available, PRs = Pakistan rupees. a At fiscal year-end in June. Source: Leasing Association of Pakistan.

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

Type of Institution 1990a 1995a 1996a 1997a 1998a 1999a 2000a,b 2001a 2002a 2003a Scheduled Banks 555.7 1,118.1 1,275.0 1,436.5 1,556.3 1,654.0 1,807.6 1,942.3 2,223.2 2,545.9 Public Sector Banks 392.3 610.4 656.5 696.9 789.3 844.1 902.0 946.5 877.6 963.1 Domestic Private Banks 73.5 265.5 313.4 373.4 405.5 448.7 513.5 565.9 967.5 1,211.6 Foreign Banks 33.4 152.5 212.6 268.9 263.3 252.6 280.6 323.7 279.6 271.2 Specialized Banks 56.5 89.7 92.5 97.3 98.2 108.6 111.5 106.2 98.5 100.0 DFIs 51.2 113.5 125.4 159.5 131.5 103.491.5 61.1 68.7 79.2 Investment Banks 2.4 30.5 36.8 41.7 45.9 48.7 41.5 28.0 27.0 34.4 Leasing Companies 6.3 20.4 27.4 31.4 33.0 35.5 40.9 48.0 46.2 45.8 Modarabas — 12.8 12.7 13.9 15.2 14.815.4 15.5 17.5 16.1 Housing Finance Companies 16.5 19.4 20.2 20.4 21.3 21.5 22.3 23.6 22.4 21.5 Discount Houses 0.9 0.8 1.0 1.5 1.6 1.6 1.8 1.4 1.5 2.0 Venture Capital Firms 0.0 0.1 0.1 0.6 1.3 1.3 1.0 0.4 0.3 0.9 Total 633.0 1,315.7 1,498.6 1,705.5 1,806.1 1,880.92,022.0 2,120.3 2,406.8 2,745.7 (As % of GDP) (74.1%) (70.0%) (70.9%) (70.2%) (67.4%) (64.0%) (53.3%) (50.9%) (54.7%) (57.0%) — = not available, DFI = development finance institution, GDP = gross domestic product, PRs = Pakistan rupees. a At fiscal year-end—December for scheduled banks and June for other financial institutions. b Government rebased GDP in FY2004 with retrospective effect from FY2000. Revised GDP size for FY2000 was higher by 20.5%. Sources: Financial Sector Assessment 2002–2003 (State Bank of Pakistan, Research Department), and Economic Survey of Pakistan 2003–2004 (Ministry of Finance).

Appendix 3 Appendix 6 61

Table A3.7: Privatization of Management Rights of ICP Mutual Funds 62

Number of Aggregate NAV Sale Proceeds Lot Name Funds (PRs million) (PRs million) Date Acquirer Appendix 3 ICP Lot A 12 1,402 175 September 2002 ABAMCO ICP Lot B 13 1,713 303 October 2002 PICIC

ICP SEMF 1 2,667 787 April 2003 PICIC Total 26 5,782 1,265 ABAMCO = ABAMCO Limited, ICP = Investment Corporation of Pakistan, NAV = net asset value, PICIC = Pakistan Industrial Credit and Investment Corporation, PRs – Pakistan rupees, SEMF = State Enterprise Mutual Fund. Source: Privatization Commission.

Table A3.8: National Savings Schemes and Money Supply (PRs million)

Fiscal Year NSS Amount M2 NSS/M2 Endinga Outstanding Net Flow Growth (%) Outstanding Net Flow Growth (%) 1994 215,969 37,036 20.7 662,805 95,636 16.9 32.6 1995 255,513 39,545 18.3 772,998 110,193 16.6 33.1 1996 303,893 48,380 18.9 938,634 165,636 21.4 32.4 1997 372,331 68,438 22.5 1,053,234 114,600 12.2 35.4 1998 483,861 111,530 30.0 1,206,319 153,085 14.5 40.1 1999 623,584 139,723 28.9 1,280,547 74,228 6.2 48.7 2000 714,954 91,370 14.7 1,400,633 120,086 9.4 51.0 2001 761,704 46,750 6.5 1,526,658 126,025 9.0 49.9 2002 846,627 84,923 11.1 1,761,370 234,712 15.4 48.1 2003 982,480 135,853 16.0 2,078,769 317,399 18.0 47.3 2004 982,737 257 0.0 2,486,556 407,787 19.6 39.5 2005 (up to February) 975,123 (7,614) (0.8) 2,758,085 271,529 10.9 35.4 M2 = money supply, NSS = national savings scheme, PRs = Pakistan rupees. a Except where indicated, the year-end is June. Source: State Bank of Pakistan.

Appendix 3 Appendix 6 63

Table A3.9: Growth and Financial Deepening 64

Fiscal Year Real GDP CPI Endinga Growth (%) Inflation (%) M2 Growth (%) M2/GDP (%) Appendix 3 1994 4.5 11.3 16.9 42.3 1995 5.3 13.0 16.6 41.1

1996 6.8 10.8 21.4 44.4 1997 1.9 11.8 12.2 43.4 1998 4.3 7.8 14.5 45.0 1999 4.2 5.7 6.2 43.6 2000 3.9 3.6 9.4 36.9 2001 1.8 4.4 9.0 36.7 2002 3.1 3.5 15.4 40.0 2003 5.1 3.3 18.0 43.1 2004 6.4 4.6 19.6 45.6 CPI = consumer price index, GDP = gross domestic product, M2 = money supply. a The year-end is June. Sources: State Bank of Pakistan for the monetary data, Economic Survey of Ministry of Finance for GDP data, and Federal Bureau of Statistics for inflation data.

Table A3.10: Benchmark Interest Rates (%)

b SBP Discount 6-Month Treasury Bill Export Financing Month Ended Rate Yielda Scheme

June 1994 15.0 10.8 13.0 June 1995 15.0 12.6 13.0 June 1996 17.0 15.1 13.0 June 1997 19.0 16.3 13.0 June 1998 18.0 15.4 11.0 June 1999 13.0 10.7 8.0 June 2000 11.0 7.2 8.0 June 2001 14.0 12.5 10.5 June 2002 9.0 6.5 8.0 June 2003 7.5 1.7 3.5 June 2004 7.5 2.2 3.5 April 2005 9.0 7.2 6.5 SBP = State Bank of Pakistan. a Simple average of auction cutoff yields for the month. b Month-end interest rate ceiling for the export financing scheme for which refinancing is provided by SBP. Source: State Bank of Pakistan.

Appendix 3 Appendix 6 65

MANAGEMENT RESPONSE ON THE PROJECT PERFORMANCE EVALUATION REPORT ON THE CAPITAL MARKET DEVELOPMENT PROGRAM (Loan 1576-PAK and Loan 1577-PAK[SF])

On 2 December 2005, the Director General, Operations Evaluation Department, received the following response from the Managing Director General on behalf of Management:

1. We concur with the overall successful rating of the Capital Market Development Program (CMDP). We note that the CMDP made a significant contribution to the development of the capital market in Pakistan.

2. However, we do not agree with the assessment that the corporate debt market component (para. 30) was only partly successful. In our opinion, the corporate debt market development should be assessed from a longer term perspective. As the PPAR notes, since the CMDP was implemented, the systems and procedures for trading, clearing and settlement of corporate debt have been developed. Backed by such a development in market systems, corporate debts have now become more attractive than commercial borrowing, especially with the recent increase in lending rates of commercial banks.

3. On the lessons identified, we agree with the importance of the ownership of reforms by key stakeholders and will keep sustained policy dialogue. The need to coordinate the implementation of programs/projects and technical assistance to facilitate compliance with policy actions is noted.