3.3.2 Regulatory Actions
The Commission, since its inception in 1999, has been conscious of the importance of the mutual funds industry in channeling savings to productive sectors of the economy and bringing qualitative improvement in stock market operations. The Mutual Funds Wing of the SCD has, therefore, taken necessary steps to create an environment conducive to the growth of the industry. Various internal and external factors inhibiting growth of the industry have been identified and measures are being taken to introduce necessary reforms.

i) Notification of Amendments in the IC & IA Rules, 1971
Through amendments made in 1999, mutual funds were allowed to diversify their portfolios by investing in fixed income securities besides investing in equities. Another set of amendments, notified in 2001, are expected to further facilitate the industry in view of the following:

a) Floatation of special purpose funds has been permitted.
b) The CDC, whose charges are lower than those of banking companies, has been allowed to function as custodian.
c) Remuneration of management companies of closed-end mutual funds has been brought at par with that of management companies of open-end mutual funds.
d) Reporting of NAV to the Commission, stock exchanges and their representative body has been made mandatory for monitoring purposes.

ii) Notification of Amendments in the Asset Management Companies Rules, 1995
During the year, amendments in the Asset Management Companies Rules with the following salient features were notified:

a) Allowing asset management companies to launch additional schemes with reduced minimum capital requirement subject to fulfillment of the prescribed performance criteria.
b) Allowing the establishment of sector-specific funds, thus encouraging investment in certain priority areas such as information technology.
c) Enabling the Commission to relax certain requirements of the Rules in the interest of the capital market.

iii) New Registrations
There is considerable interest amongst corporate houses for launching open-end funds and five applications for registration of companies under the Asset Management Companies Rules, 1995 were received during the year. After reviewing the proposals, registration was granted in one case while promoters of the remaining four companies were asked to complete requisite formalities to become eligible for registration. The documents for launching the scheme by the new asset management company are currently under the scrutiny of the Commission.

The Commission also received and processed applications from three different corporate houses for registration of companies as investment advisors under the IC & IA Rules. Registration was granted to one of the applicants while the remaining two were advised to fulfill the criteria stipulated in the Rules. At present, 59 companies are registered as investment advisors. The number of closed-end mutual funds remained 13 owing to lack of investor interest in new funds under existing market conditions.

iv) Update of Record of Investment Advisors
Recent amendments in the IC & IA Rules have o raised the minimum paid-up capital requirement for investment advisors to Rs. 20 million and for investment companies to Rs. 100 million. Compliance with this stipulation is expected by January 14, 2002. Registration of three investment advisors was cancelled due to non-compliance with certain provisions of the IC & IA Rules while one company is in voluntary liquidation. A No Objection Certificate (NOC) issued to promoters of an investment advisory company was withdrawn since they failed to incorporate the company within the validity period of the NOC.

v) Mergers and Consolidation
A trend of consolidation was also witnessed in the mutual funds industry during the period under review and two closed-end funds applied for merger. In view of the complementarities and synergies noted, the Commission cleared the scheme of merger. In line with the policy to encourage consolidation in the corporate sector, the minimum capital requirement was increased for investment advisors and investment companies as noted above.

vi) Other Regulatory Actions
The Commission approved, after due examination, advertisements submitted by fund managers of open-end mutual funds ensuring that no misleading information was passed on to investors while inviting investment in the schemes. Similarly, requests received for appointment of directors by investment companies and investment advisors were examined and approved after ensuring that the new directors fulfilled the criteria prescribed in the Rules. As a consequence of allowing CDC to act as custodian of mutual funds, several requests were received for change of custodian which were approved after necessary scrutiny.

vii) Registration of Mutual Funds Association of Pakistan
The mutual funds sector has also formed a representative body, namely, Mutual Funds Association of Pakistan (MUFAP). The Commission has cleared the Memorandum of Association of MUFAP and asked the Ministry of Commerce to register it under the Trade Organization Ordinance, 1961.

3.3.3 Monitoring and Enforcement
i) Development of New Monitoring System
During the period under review, a new system was devised for monitoring the performance of mutual funds that was hitherto being monitored solely on the basis of annual and half-yearly accounts. The new monitoring system has the following features:

a) Performance of each mutual fund is analyzed in terms of NAV, profitability, payout and market price. Changes in NAV of different funds are also compared with the KSE-100 Index. Managements of funds, whose performance is found unsatisfactory, are called upon to explain their investment strategy and future business plans to improve performance.

b) In the light of provisions contained in the Rules, a checklist of indicators for performance evaluation has been devised. On the basis of these indicators, most mutual funds have been asked to explain their position with regard to issues like inadequate disclosure, incorrect calculation of remuneration fee of investment advisors, investments in associated undertakings, incorrect treatment of investments in annual accounts, insufficient provisioning against diminution in the value of investments, poor trading results, imprudent deployment of funds and unusual increase in administrative expenses.

c) To standardize the monitoring system, Prudential Regulations have been drafted for the mutual funds industry and will be notified for public opinion shortly. The Regulations define investment valuation, investment policy, diversification, restrictions on certain types of transactions, transactions with directors/connected persons, distribution of profits, provision for inspection/special audit, code of conduct, internal control, etc. The Regulations also contain formats of periodic statements to be submitted by the companies to the Commission for monitoring purposes.

ii) Enforcement Actions
The following major irregularities on the part of investment advisors and funds were observed during the period under review:
a) Irregularities in appointment of directors.
b) Late filing of accounts.
c) Non-holding of Annual General Meetings (AGMs).
d) Continuous deterioration in financial position.
e) Mismanagement of funds.

Non-compliant funds and investment advisors were issued Show Cause notices to explain their position with regard to the above violations. After necessary due process, orders were issued against those funds and investment advisors which were found to be persistent defaulters. Penal actions taken include the following:

a) A fine amounting to Rs. 100,000 under the Securities and Exchange Ordinance, 1969 was imposed on the CEO of an investment advisory company for not seeking approval of the Commission, as required under the IC & IA Rules, for appointment of directors.

b) A penalty amounting to Rs. 20,000 under the Companies Ordinance, 1984 was imposed on each of the directors of a mutual fund for failing to hold the AGM and file annual accounts within the stipulated time.

c) An investigation was ordered into the affairs of an investment advisory company and a mutual fund under Section 265(b) of the Companies Ordinance, 1984 for reported mismanagement and financial irregularities.

d) Registration of certain investment advisory companies was cancelled due to violation of IC & IA Rules, 1971.

3.3.4 Other Specialized Companies
The Mutual Funds Wing also looks after the affairs of the following specialized companies other than mutual funds:

i) Credit Rating Companies
At present, there are two credit rating companies, namely, Pakistan Credit Rating Company (Pvt.) Limited (PACRA) and JCR-VIS Credit Rating Company (formerly DCR-VIS) operating in Pakistan, which were registered in 1996 and 1997, respectively, under the Credit Rating Companies Rules, 1995. The Commission renews their registration annually on the basis of performance and compliance with the registration criteria. Fitch Ratings is a shareholder and technical partner of PACRA while Japan Credit Rating Agency has similar arrangements with JCR-VIS. JCR-VIS had technical collaboration with Duff & Phelps Credit Ratings till the latter merged with Fitch IBCA in June 2000 and withdrew its technical collaboration with DCR-VIS. Consequently, the promoters of DCR-VIS were directed to conclude a joint venture agreement with an international credit rating agency to stay eligible for renewal of registration. The company's registration certificate was renewed after it entered into a technical assistance agreement with Japan Credit Rating Agency.

Credit ratings serve as a useful tool for investment evaluation especially for investors in the corporate debt market. The Commission has made it mandatory for the issuers of corporate bonds/TFCs to get these instruments rated by recognized credit rating agencies. The SBP has also made it obligatory for commercial banks and NBFIs under its purview to get themselves rated. With the development of the corporate bond market, it is anticipated that the role of rating agencies would also assume greater significance in the future.

ii) Venture Capital Companies and Venture Capital Funds
The Commission notified the Venture Capital Companies and Venture Capital Funds Rules (VCC & VCF Rules) in February 2001. These Rules provide the legal framework to govern licensing, operations, resource generation and investment avenues for venture capital companies and venture capital funds. The Rules - framed under the Securities and Exchange Ordinance, 1969 - are expected to facilitate investment in business ventures such as information technology companies. Companies licensed under the VCC & VCF Rules have been granted tax exemption for a period of seven years by the Government, effective from July 1, 2000. The text of the Rules is available at the Commission's website.

3.4 Oversight of Accountancy Profession
The Commission has been entrusted with oversight of the accounting profession, in particular the Institute of Chartered Accountants of Pakistan (ICAP). The Chairman is a nominee of the GOP on the Council of ICAP. This enables the Commission to contribute to, and remain abreast of all major policy decisions of the Institute.

3.4.1 Chartered Accountants (Amendment) Ordinance, 2001
The draft Chartered Accountants (Amendment) Ordinance, 2001 submitted by ICAP to the Commission was, after due consideration, sent to the Ministry of Finance for clearance. This Ordinance envisages a number of amendments in the Chartered Accountants Ordinance, 1961 and primarily seeks to enhance self-regulation of the profession through a more effective regulatory framework. The proposed amendments are essentially designed to convert the Chartered Accountants Ordinance, 1961 into an 'enabling law' that lays down the basic framework leaving all operative matters to be covered in the bye-laws.

3.4.2 Corporate Secretaries Ordinance, 2001
The Commission has also drafted and proposed promulgation of Corporate Secretaries Ordinance, 2001 to the Ministry of Finance. This Ordinance seeks to grant the Institute of Corporate Secretaries (ICS) the status of a statutory body. ICS is, at present, operating as a company limited by guarantee under the repealed Companies Act, 1913. It is a professional institute, representing corporate secretaries in Pakistan, with membership strength of about 550.

3.4.3 Adoption of International Accounting Standards
The Commission has approved the notification for adoption of International Accounting Standards (IAS) 22, 36 and 39, pursuant to the recommendations of ICAP. Effectively, the Commission has adopted all IAS issued so far with the exception of two that are yet to be recommended by ICAP and another two that are not relevant to the circumstances in Pakistan.

3.4.4 Amendments in the Companies Ordinance, 1984
During the year, amendments were considered in Section 254 of the Fourth Schedule to the Companies Ordinance, 1984, as discussed below.

i) Section 254
The Companies Ordinance, 1984 lays down the qualification of auditors of private companies with paid-up capital of Rs. 3 million or more. No qualification criterion has, however, been prescribed for auditors of private companies with paid-up capital of less than Rs. 3 million. After a public hearing at which all aspects of this matter were debated, the Commission announced its considered view that private companies with paid-up capital of less than Rs. 3 million but with both turnover and total assets exceeding Rs. 21 million should have their accounts audited by a Chartered Accountant. Necessary amendments to this effect, in the Companies Ordinance, 1984, have been proposed.

ii) Fourth Schedule
The Commission has undertaken to remove obsolete clauses in the Fourth Schedule to the Companies Ordinance, 1984, which is titled "Requirements as to Balance Sheet and Profit and Loss Account of Listed Companies". The purpose is to bring the disclosure and presentation requirements for financial statements of listed companies in line with IAS.

3.4.5 Amendments in the Companies (General Provisions and Forms) Rules, 1985
During the year, two significant amendments were made in the Companies (General Provisions and Forms) Rules, 1985 whereby Form 35-A "Auditors' Report to the Members" and Form 35-B "Auditors' Report to the Members or Directors in case of Branches of Foreign Banks" were substituted. The purpose was to ensure that financial statements conform with approved accounting standards, as applicable in Pakistan, and to delineate the responsibilities of auditors and management. In addition, auditors of banks are now required to verify more than 60 percent of the loans and advances of the bank and a necessary statement to this effect has been included in Form 35-B.

3.5 Cost Audit Records
3.5.1 Companies (Audit of Cost Accounts) Rules, 1998
Audit of cost accounts by a Chartered Accountant or a Cost and Management Accountant is a statutory requirement contained in the Companies Ordinance, 1984 under Section 230(1)(e). The rules framed under this Section were notified in 1998 as the Companies (Audit of Cost Accounts) Rules, 1998.

Cost Audits in all major industries would help the companies to identify the inefficiencies in their costing mechanisms and pave the way for rationalization of costs thereby increasing profitability and enhancing shareholder value. Cost Audits have already been enforced in Vegetable Ghee and Cooking Oil Industry since January 1991 and in Cement Industry since July 1994. The Sugar Industry came under the ambit of Cost Audits with effect from October 2001.