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Specialized Companies Division

The Specialized Companies Division (SCD) is responsible for the regulation and monitoring of leasing companies, modarabas, mutual funds and other specialized companies. Accordingly, the SCD is divided into three Wings for operational purposes, i.e. Leasing, Modaraba and Mutual Funds Wings. In addition, the SCD also maintains regulatory oversight of the accountancy profession. A brief review of the activities of the respective Wings is presented below.

3.1 Leasing Wing
3.1.1 Overview
Previously regulated by the SBP, the regulation of leasing companies came under the purview of the erstwhile CLA in 1997 consequent to amendments in the Banking Companies Ordinance, 1962. At present, the Leasing Wing of the SCD monitors and regulates leasing companies in accordance with the provisions of the Leasing Companies (Establishment and Regulation) Rules, 2000 that have been framed under Section 506 of the Companies Ordinance, 1984. The supervision of leasing companies is carried out with the core objective of facilitating and promoting their legitimate operations while at the same time, protecting and safeguarding the interests of minority shareholders and other stakeholders in these companies.

At present, the leasing sector comprises 32 listed companies, of which one is in liquidation. The sector has shown considerable growth since its inception in 1984 with the establishment of the first leasing company - National Development Leasing Corporation (NDLC) - and had an aggregate asset and equity base of Rs. 46.78 billion and Rs. 8.92 billion, respectively, as at June 30, 2001I. With nearly 76 percent of assets deployed in its principal line of business, the leasing sector forms an important component of the overall financial sector and plays a significant role in the country's fixed capital formation. The sector, however, depicts high concentration with five large companies representing more than 67 percent of the total leases undertaken by the leasing sector.

The sector had shown significant growth in the late eighties and early nineties owing to burgeoning economic growth, increasing demand for corporate credit, availability of accelerated depreciation allowances that helped in reducing current tax liability, and easy access to multi-lateral and local funding. During this period, leasing of plant and machinery remained the focus of almost all leasing companies. At times, these companies also went into financing development finance projects that are conventionally regarded as not suitable for leasing. Moreover, weak risk assessment and imprudence resulted in over-exposure to certain risk-prone industrial sectors that subsequently became non-performing.

During the last few years, the growth rate of the sector has fallen considerably as a result of the drying up of multi-lateral credit lines and decline in industrial activity - largely stemming from the economic slow down. As demand for corporate credit has been greatly reduced, most leasing companies have shifted their focus from plant and machinery leasing to consumer leasing - mostly vehicles. However, owing to the legacy of imprudent leasing in the past, the asset quality of some leasing companies is adversely impacted with a significant increase in the proportion of non-performing leases. Earnings in the leasing sector have also declined as a consequence of lower margins due to increased competition, especially from investment banks and development finance institutions that have also started leasing operations. The larger leasing companies, however, have managed to weather this difficult period as they were adequately capitalized. On the other hand, the smaller companies, being thinly capitalized, were hit harder by the economic downturn.

3.1.2 Regulatory Actions
1. Requirement for Increase in Paid-up Capital to Rs. 200 million
In view of the fragmented state of the leasing sector, the minimum paid-up capital requirement for leasing companies was raised to Rs. 200 million from Rs. 100 million in 1997. The aim is to enhance financial stability and resource mobilization potential and to encourage consolidation through mergers and acquisitions. All leasing companies were advised to become compliant with the paid-up capital requirement by October 30, 1999. However, in view of the economic stagnation and weak capital market conditions the deadline was extended to June 30, 2001.

At the close of the financial year 2000, only nine leasing companies were fully compliant with the minimum paid-up capital requirement of Rs. 200 million and by December 31, 2000, the number had increased to 12. Despite a number of requests, both from the Leasing Association of Pakistan (LAP) as well as individual companies whose paid-up capital was below the stipulated level, the Commission maintained a firm stance that no further relaxation in the time frame for compliance would be granted on an industry-wide basis. However, individual cases were considered on a case-to-case basis and depending on the viability of their plans to meet the regulatory requirement, relaxation was allowed as appropriate.

During the period under review, to provide additional relief to companies whose paid-up capital was below the requisite level, the Commission deemed it fit to consider that the statutory reserves and free reserves available for distribution of bonus shares may be treated as part of capital for meeting the requirement of Rs. 200 million. An amendment to this effect has also been proposed in the Leasing Rules. Consequent to this amendment, two leasing companies would become compliant while five companies are expected to become compliant as a result of mergers and issuance of rights at a discount, thus bringing the number of compliant companies to 19. Meanwhile, the remaining non-compliant companies have also submitted plans to meet the regulatory requirement. Some of these proposals are under consideration of the Commission while companies whose plans were found inadequate have been advised to submit revised plans within the shortest possible time. As a result of these concerted efforts, more than 70 percent of the leasing companies would have met the minimum capital requirement by the end of calendar year 2002. The expected mergers, acquisitions and right issues are likely to lend an element of financial stability to the leasing sector.

Expected to Become Compliant as a result of Merger / Issuance of Right Shares
15. Ghandhara Leasing Company Limited merging with Al-Zamin Leasing Modaraba (merger in progress).
16. Ibrahim Leasing Limited merging with Ibrahim Modaraba (merger approved by High Court)
Mercantile Leasing Company Limited merged with Universal Leasing Corporation Limited (merger approved by High Court)
19. Pacific Leasing Company Limited has been granted no-objection for issuance of 100% Rights with a discount of 30%.

Suspension of License to Issue Certificates of Investment
Certificates of Investment (COI) remained a significant source of mobilizing short and medium term funding for 21 companies in the leasing sector and as at June 30, 2001, the aggregate amount raised through this source was Rs. 11.5 billion II. A number of leasing companies were issued licenses to issue COIs in the past when the requirement of having a minimum investment grade rating was not mandated by the Commission since no credit rating company was in existence. However, subsequent to the establishment of credit rating agencies and the promulgation of Leasing Companies (Establishment and Regulation) Rules, 1996, the condition of obtaining a minimum investment grade credit rating was imposed for seeking permission to issue COIs. In order to ensure uniform applicability of the Leasing Rules, it was deemed necessary that all leasing companies, which are mobilizing deposits through the issuance of COIs, must obtain a minimum investment grade credit rating.

Until recently, six leasing companies had credit ratings that were below investment grade. As such, issuance of COIs by these companies was in violation of the Leasing Companies (Establishment and Regulation) Rules, 2000. Therefore, in the interest of the depositors and prospective COI holders, the Commission suspended their licenses to issue COIs. In case these companies fail to obtain an investment grade credit rating within a period of two years (i.e. by June 30, 2003), their licenses would be cancelled. During this two-year period, these companies have been advised neither to issue any new COIs nor roll-over the existing COI deposits upon maturity. The companies whose licenses to issue COIs have been suspended are as follows:

a) National Assets Leasing Company Limited
b) Natover Lease and Refinance Limited
c) English Leasing Limited
d) First Leasing Corporation Limited
e) InterAsia Leasing Company Limited
f) Lease Pak Limited

2. Promulgation of Leasing Rules, 2000
The Leasing Companies (Establishment and Regulation) Rules, 2000 were notified and published in the official Gazette of September 25, 2000. These Rules provide a comprehensive regulatory framework for leasing companies as both establishment rules and SBP's Prudential Regulations applicable to leasing companies have been combined in one document.

3. Permission to Investment Banks and Development Finance Institutions to Undertake Leasing Business
During the year under review, after deliberations with representatives of various professional bodies and associations, the Commission acceded to the long standing request of investment banks and development finance institutions and granted them permission to undertake leasing business, strictly within the terms of the regulatory framework for leasing, including compliance with the stipulated minimum capital requirements. Consequent upon this decision, licenses to undertake leasing business have been accorded to Saudi Pak Investment and Agricultural Company (Pvt.) Limited, Al-Meezan Investment Bank Limited and Pakistan Industrial Credit and Investment Corporation Limited (PICIC).

4. Approval of Directors
The Commission approved the appointment of 52 Directors and four CEOs in response to requests received from 15 leasing companies. In addition, appointments of Chief Operating Officers of Saudi Pak Investment and Agricultural Company (Pvt.) Limited, Al-Meezan Investment Bank Limited and PICIC were also cleared by the Commission.

5. Grant of Permission to Issue COIs
Security Leasing Company Limited and Sigma Leasing Corporation Limited applied for grant of permission to issue COIs, which was granted by the Commission after all regulatory conditions in this regard had been fulfilled by these companies.

6. Working Paper for Amendments in Leasing Rules
To make Leasing Companies (Establishment and Regulation) Rules, 2000 more comprehensive and practicable, certain amendments were proposed after extensive discussions with LAP in different forums. These amendments aim not only to provide a level playing field to leasing companies vis-à-vis other Non-Bank Financial Institutions (NBFIs) but will also serve to promote the legitimate operations of leasing companies. The amendments, as finally approved by the Commission, are with the Ministry of Finance for clearance before publication to solicit public opinion.

7. Budget Proposals for the Finance Ordinance, 2001
Tax proposals in respect of leasing companies, after consultation with LAP, were forwarded to the Central Board of Revenue for their consideration and eventual conclusion in the Finance Ordinance, 2001. As a result of concerted efforts of the Commission, First Year Allowance at the rate of 30 percent has been allowed to leasing companies and modarabas. Also, the ceiling on cost of vehicles for depreciation allowance has been revised upward from Rs. 600,000 to Rs. 750,000. These measures are expected to give a significant boost to the performance of leasing companies through tax deferrals and reduced current tax liabilities.

3.1.3 Monitoring and Enforcement
1. Prescription of New Periodic Statements and Returns
The format of periodic statements and returns to be filed by leasing companies was revised in line with the Leasing Companies (Establishment and Regulation) Rules, 2000. As a result of revision and consolidation, the total number of statements has been reduced from 25 to 10. These were circulated vide circular No.21/2000 dated December 26, 2000 to all leasing companies for compliance with effect from January 1, 2001. This has resulted in not only reducing unnecessary paperwork for leasing companies but has also improved the quality of surveillance by the Leasing Wing.

2. Special Audit of Leasing Companies
During the year under review, all leasing companies were subjected to independent Special Audits in terms of Rule 19 of the Leasing Companies (Establishment and Regulation) Rules, 2000. In this regard, comprehensive terms of reference were prepared and Special Auditors appointed to complete the task. The Special Audit Reports received were duly reviewed and appropriate proceedings initiated wherever deemed necessary.

3. Investigation into the Affairs of Leasing Companies
After an investigation conducted under Section 265 of the Companies Ordinance, 1984, the Commission initiated court proceedings against the ex-management of Universal Leasing Corporation Limited for misappropriation/misapplication of funds and to seek reimbursement of losses suffered by the company. It has also been decided after necessary due process to investigate into the affairs of National Assets Leasing Corporation Limited under Section 265 of the Ordinance.

4. Show Cause Notice Under Section 208 of the Companies Ordinance, 1984
On the basis of the review of annual accounts and Special Audit Reports, Show Cause notices under Section 208 of the Companies Ordinance, 1984 have been issued to two leasing companies for allegedly investing more than 30 percent of their equity into associated undertakings/companies. Consequential proceedings are in progress.

5. Order Under Rule 7 (1)(i) of Leasing Rules, 1996
Each leasing company is required to invest at least 70 percent of its assets in its principal line of business in terms of Rule 7(1)(i) of the Leasing Rules, 1996. Continued violation of this Rule was observed in the case of a leasing company, the Directors of which were imposed a penalty of Rs. 57,200 under Rule 14 (1) of the Leasing Rules, 1996.

3.2 Modaraba Wing
3.2.1 Overview
The Islamic concept of 'modaraba' was first introduced in the financial sector in Pakistan in 1980 with the promulgation of the Modaraba Companies and Modaraba (Floatation and Control) Ordinance. The Modaraba Ordinance provides for an Islamic mode of business termed 'modaraba' in which one party (the modaraba management company) contributes its skills and efforts while the other (the modaraba certificate holders) provides the required capital/funds, the profits earned being shared between them in a pre-agreed proportion. A modaraba may be multi-purpose or specific purpose, and may be perpetual or floated for a specified period.

Representing the first step towards Islamization of the economy, this sector has come a long way since its inception in 1980 and modarabas have contributed considerably towards the economic development of the country. The modaraba, being essentially an Islamic corporate form akin to a two-tier fund structure, derives its strength and vitality from the capability of its management company. This calls for a stricter code of corporate governance in order to safeguard the interests of the modaraba certificate holders. With better monitoring and surveillance methods recently instituted by the Commission, compliance with the Prudential Regulations has improved. Also, the enhanced disclosure requirements have helped in maintaining greater transparency in the sector.

The modaraba sector has suffered chronically from the problem of resource mobilization resulting in limited opportunities for growth. The Commission is aware of the difficulties being faced by the sector in this respect and plans to take effective steps in collaboration with the SBP to improve the operating environment of the sector. Meanwhile, the recent mergers in the sector are also indicative of a general strategic shift towards consolidation that is expected to usher in greater financial stability and operational flexibility.

At June 30, 2001, there were 47 modarabas in existence, of which 41 were operational with paid-up capital aggregating Rs. 7.4 billion. Total assets of the modaraba sector stood at Rs. 17.12 billion while their aggregate equity amounted to Rs. 8.1 billionIII. The difficult operating environment prevailing in the recent past has also had an adverse impact on the performance of a number of modarabas. However, despite the long economic recession, the sector has performed reasonably well and out of 41 operational modarabas, 35 were profitable with 23 paying cash dividends during the financial year 2001. The Net Asset Value (NAV) of the majority of the modarabas remained above par value. The average dividend payouts of the modaraba sector can be compared favorably with any other segment of the corporate sector.

Key statistics of the modaraba sector as on June 30, 2001, based on unaudited statements, are given in Table 7 ahead.

Table 7 - Key Statistics of Modaraba Sector
(Rs. in million)

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