SECURITIES AND EXCHANGE COMMISSION OF PAKISTAN
SPECIALIZED COMPANIES DIVISION

No. SC/M/RS/PR/2004-

January 28, 2004

CIRCULAR No. 4 OF 2004

Subject:         Prudential Regulations for Modarabas

The Securities and Exchange Commission of Pakistan (SEC) has revised the existing Prudential Regulations for Modarabas issued vide Circular No. 5/2000 dated April 20, 2000 and subsequent amendments made therein vide Circular No. 20 of 2000 dated December 21, 2000 and Circular No. 4 of 2001 dated June 14, 2001.

All the Modaraba Companies are hereby directed to conduct all business transactions undertaken by the modarabas in conformity with the revised Prudential Regulations enclosed herewith as Prudential Regulations for Modarabas (the "Regulations"). These Regulations shall come into force with immediate effect.

These Regulations are being issued in super cession of this office Circular No. 5/2000 dated April 20, 2000, Circular No. 20 of 2000 dated December 21, 2000 and Circular No. 4 of 2001 dated June 14, 2001. However, it is clarified that the modaraba companies shall continue to submit all the information, returns and statements etc. in the same manner and format as previously prescribed vide circular No. 10/2000 dated August 10, 2000.

Modaraba Companies are advised to ensure circulation of Regulations among all their officers/ branches for meticulous compliance in letter and spirit. Any violations or circumvention of these Regulations shall be dealt with under the provisions of the Modaraba Companies and Modaraba (Floatation and Control) Ordinance, 1980.

The new set of Regulations has also been placed on SEC Website www.secp.gov.pk for information of the concerned quarters and general public.

Please acknowledge receipt.

(Akbar Shah)

Registrar Modaraba Companies and Modarabas

Distribution:

1.     Chief Executives of all Modaraba Companies.

2.                                         Managing Directors of all Stock Exchanges

3.                                         The Chairman, Modaraba Association of Pakistan

4.                                         The Institute of Chartered Accountants of Pakistan, Karachi.

5.                                         The Institute of Cost and Management Accountants of Pakistan, Karachi.

6.                                         Office copy.

PRUDENTIAL REGULATIONS FOR MODARABAS

1.          Short title and commencement: - (1) These additional conditions shall be deemed to be
part of the conditions of the certificate granted for authorization to float a modaraba in terms of
powers conferred by Section 11 of the Modaraba Companies and Modaraba (Floatation &
Control) Ordinance, 1980 read with rule 3 (2) (e) of Modaraba Companies and Modaraba Rules,
1981 and may be called as Prudential Regulations for Modarabas.

(2) These regulations shall be applicable at once.

Part -I

2.          Definitions.__ (1) In these Regulations, unless there is anything repugnant in the subject
or context:-

(a)                                     Borrower includes a person on whom a modaraba has taken any exposure during
the course of business.

(b)                                    Contingent liability means:

(i) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise; or

(ii) a present obligation that arises from past events but is not recognized because:

(a)            it is not probable that an outflow   of resources embodying economic
benefits will be required to settle the obligation; or

(b)           the  amount  of the  obligation  cannot     be  measured with  sufficient
reliability;

and includes letters of credit, letters of guarantee, bid bonds / performance bonds, advance payment guarantees and underwriting commitments.

(c)                                     Documents   include   vouchers,   cheques,  bills,   pay-orders,   promissory  notes,securities for leases / advances and claims by or against the modaraba or any other record / papers supporting entries in the books of a modaraba.

(d)                                    Equity includes paid up fund, reserves, balance of premium account and un­ appropriated profits/accumulated losses excluding deferred tax reserves, surplus on revaluation of fixed assets accounts as described in section 235 of the Companies Ordinance, 1984 and treasury stocks.

(e)                                     Equity of the Borrower includes paid-up capital, general reserves, balance in share premium account, reserve for issue of bonus shares and retained earnings / accumulated   losses,   revaluation   reserves   on   account  of  fixed   assets   and subordinated loans.

 

Explanation: Revaluation reserves will remain part of the equity for first three years only, from the date of asset revaluation, during which time the borrower will strengthen its equity base to enable it to avail facilities without the benefit of revaluation reserves.

(f)          Exposure includes facilities and subscription to or investment in shares.

Explanation: Secured exposure means exposure backed by tangible security and any other form of security with appropriate margins (in cases where margin has been prescribed by SEC, appropriate margin shall at least be equal to the prescribed margin). Clean exposure means exposure without any security or collateral.

(g)         Facility includes a financing under a system which is based on participation in profit and loss, mark-up or mark-down in price, hire-purchase, lease, rent-sharing,
bills of exchange, promissory notes or other instruments with or without buy-back arrangement by a seller, participation term certificate, musharika or modaraba
certificate, term finance certificate or any other mode, guarantees, indemnities, letters of credit and any other obligation, whether fund based or non-fund based;

(h)       Financial Institutions includes, -

(a)                                a  company  or an  institution whether  established under  any  special enactment and operating within or outside Pakistan which transacts the
business of banking or any associated or ancillary business through its branches;

(b)                               a modaraba, leasing company, investment bank, venture capital company, financing company,  housing finance company,  a non-banking finance
company and bank or any institution duly licensed by State Bank of Pakistan; and

(c)                                such other institution or companies authorised by law to undertake any similar business, as the Federal Government may, by notification in the
official Gazette, specify for the purpose;".

(j) Forced Sale Value (FSV) means the value which fully reflects the possibility of price fluctuations and can currently be obtained by selling the mortgaged / pledged/ leased/collaterally held assets in a forced / distressed sale conditions.

(j) Government Securities include monetary obligations of the Federal Government or a Provincial Government or of a Corporation wholly owned or controlled, directly or indirectly, by the Federal Government or a Provincial Government and guaranteed by the Federal Government and any other security as the Federal Government may, by notification in the Official Gazette, declare, to the extent determined from time to time, to be Government Securities.

(k) Group means persons, whether natural or juridical, if one of them or his family members including spouse, lineal ascendants and descendants and brothers and sisters or its subsidiary, have control or hold substantial ownership interest or have power to exercise significant influence over the other. For the purpose of this:

(i) Subsidiary will have the same meaning as defined in sub-section 3(2) of the Companies Ordinance, 1984 i.e. a company or a body corporate shall deemed to be a subsidiary of another company if that other company or body corporate directly or indirectly controls, beneficially owns or holds more than 50% of its voting securities or otherwise has power to elect and appoint more than 50% of its directors.

(ii) Control refers to an ownership directly or indirectly through subsidiaries, of more than one half of voting power of an enterprise.

(iii)Substantial ownership / affiliation means beneficial share holding of 10% by a person and/or by his family members including spouse, lineal ascendants and descendants and brothers and sisters.

Significant influence refers to the management control of the company, to participate in financial and operating policies, either exercised by representation in the Board of Directors, partnership or by statute / agreement in the policy making process or affiliation or material inter- company transactions.

(l) Liquid Assets are the assets which are readily convertible into cash without recourse to a court of law and mean encashment / realizable value of government securities, bank deposits, shares of listed companies which are actively traded on the stock exchange, NIT Units, certificates of mutual funds, Certificates of Investment (COIs)/Certificates of Deposits (CODs) issued by DFIs / modarabas and Certificates of Musharika (COMs) issued by modarabas rated at least 'A' by a credit rating agency registered with the SEC, listed TFCs and Commercial Papers rated at least 'A' by a credit rating agency registered with the SEC, National Saving Scheme securities and units of open ended schemes for which a duly licensed asset management company quotes daily offer and bid rates. These assets with appropriate margins should be in possession of the modarabas with perfected lien.

(m)      Lease Key Money includes lease security deposit.

(n) Major Shareholder of a modaraba means any person holding 10% or more of the share capital of a modaraba either individually or in concert with family members.

(o) Medium and Long Term Facilities mean facilities with maturities of more than one year.

(p) Other Form of Security means hypothecation of stock (inventory), assignment of receivables, lease rentals, contract receivables, etc.

(q) Readily Realizable Assets include liquid assets and stocks pledged with the modarabas and are in their possession, with 'perfected lien' duly supported with complete documentation.

 

 (r) Rentals include lease rentals, rentals in respect of housing finance facilities, hire purchase installments or any other amount received by modaraba from borrower against the grant of facility.

(s)       Short Term Facilities mean facilities with maturities up to one year

(t) Subordinated Loan means an unsecured loan extended to the borrower by its sponsors, subordinate to the claim of the modaraba taking exposure on the borrower and documented by a formal sub-ordination agreement between provider of the loan and the borrower. The loan shall be disclosed in the annual audited financial statements of the borrower as subordinated loan.

(u) Tangible Security means readily realizable assets, mortgage of land, plant, building, machinery and any other fixed assets.

(v) Underwriting Commitments mean commitments given by modarabas to the limited companies at the time of new issue of equity / debt instrument, that in case the proposed issue of equity/debt instrument is not fully subscribed, the un­subscribed portion will be taken up by them (modarabas).

(2) All terms and expressions used but not defined in these regulations shall have the same meanings as in the Modaraba Companies and Modaraba (Floatation and Control) Ordinance, 1980 (Ordinance XXXI of 1980) and the Companies Ordinance 1984 (XLVII of 1984).

PART - II

(A) Corporate Borrowers

1. Limit on modaraba's exposure to a single person. -(1) The total outstanding exposure by a modaraba to any single person shall not at any point in time exceed 30% of the modaraba's equity (as disclosed in the latest audited financial statements), subject to the condition that the maximum outstanding against fund based exposure does not exceed 20% of the modaraba's equity.

(2)                                     The total outstanding exposure by a modaraba to any group shall not exceed 50% of the modaraba's equity (as disclosed in the latest audited financial  statements), subject to the condition that the maximum outstanding against fund-based exposure does not exceed 35% of the modaraba's equity.

(3)                                     In arriving at exposure under this Regulation:

 

a)                100% of the deposits placed with lending modaraba and TFCs, having investment grade credit rating by a rating agency registered with the  SEC,  of the lending modaraba shall be excluded.

b)       90% of the following shall be deducted;

(i)     deposits with another financial institution under perfected lien;

 

(ii)    encashment    value   of  Government Securities and National Saving Scheme securities, lodged by the borrower as collateral; and

(iii) Pak. Rupee equivalent of face value of Special US Dollar Bonds converted at inter-bank rate, lodged by the borrower as collateral.

c)               85% of the unconditional financial guarantees, payable on demand, issued by a financial institution rated at least 'A' by a credit rating agency registered with the SEC, accepted as collateral by modarabas shall be deducted.

d)              75% of listed Term Finance Certificates held as security with duly marked lien shall be deducted. The TFCs to qualify for this purpose should have been rated at least 'A' or equivalent by a credit rating agency registered with the SEC.

e)               Weightage of 50% shall be given to;

(i) guarantees / bonds other than financial guarantees; (ii) underwriting commitments.

f)      The following different weightages will be applicable to exposure taken against financial institutions in respect of placements:

(i)   10% weightage on exposure to financial institutions with ' AAA' rating, (ii) 25% weightage on exposure to financial institutions rated 'A' and above, (iii) 50% weightage on exposure to financial institutions rated 'BBB' and above. (4)       For the purpose of this regulation, exposure shall not include the following:

(i) Obligations under letters of credit and letters of guarantee to the extent of cash margin held by the modarabas.

(ii) Letters of credit, which do not create any obligation on the part of the modarabas (no liability L/C) to make payments on account of imports.

(iii) Facilities provided to financial institutions through REPO transactions with underlying SLR eligible securities

(iv) Pre-shipment / post-shipment credit provided to finance exports of goods covered by letter of credit/firm contracts including financing provided from the Modaraba's own resources.

(v)       Letters of credit established for the import of plant and machinery.

2. Minimum conditions for grant of financing facilities. - (1) When considering proposals for fund/non-fund based facility exceeding one million rupees, modarabas should give due weightage to credit report relating to the borrower and his group obtained from Credit Information Bureau of the State Bank of Pakistan. If the credit report indicates over-exposure/default, the facilities shall be extended only after recording reasons to do so.

(2) While granting any facility to the customers other than individuals, modaraba shall obtain copy of accounts relating to the business of each of its borrower for analysis and record in the following manner, namely:-

(3) Every modaraba shall, before providing any facility (including renewal, enhancement and rescheduling/restructuring), ensure that the Loan Application Form prescribed/devised by a modaraba is accompanied with a "Borrower's Basic Fact Sheet" as per Annexure-I. Modaraba shall also ensure that the information requested in the Basic Fact Sheet is provided by the borrower under his seal and signature.

Linkage   between   a   borrower's   equity   and   total   exposure   from   financial

institutions.- (1) While taking any exposure, modarabas shall ensure that the total exposure availed by any borrower from financial institutions does not exceed 10 times of borrower's equity as disclosed in its financial statements.

(2) For the purpose of this regulation, subordinated loans shall be counted as equity of the borrower. Modarabas should specifically include the condition of subordinated loan in their Offer Letter. The subordination agreement to be signed by the provider of the subordinated loan, should confirm that the subordinated loan will be repaid after that modaraba's prior approval.

4. Financial indicators of the borrowers: - (1) It is expected that at the time of allowing fresh exposure / enhancement / renewal, the debt-equity ratio of the borrower does not exceed 60:40 and current assets to current liabilities ratio is not lower than 1:1 or any other ratios as may be prescribed by the Registrar Modaraba from time to time. Current maturities of long term debt not yet due for payment may be excluded from the current liabilities and lease rentals receivable within the next twelve months as disclosed in the annual audited accounts shall be treated as current assets for the purpose of calculating current assets to current liabilities ratio. However, in exceptional cases, modarabas may relax these ratios in case of facilities upto three million rupees, if they are satisfied that appropriate risk mitigants have been put in place. Where the modarabas have taken exposure on exceptional basis as provided above, they shall record in writing the reasons and justifications for doing so in the approval form and maintain a file in their central credit office containing all such approvals. The Exceptions Approval file shall be made available to the inspection team of the SEC during the inspection.

(2) This regulation shall not apply to the facilities granted to financial institutions with investment grade rating by a credit rating agency registered with SEC or in case of exposure fully secured against liquid assets held as collateral. Export finance and finance provided to ginning and rice husking factories shall also be excluded from the borrowings (exposure) for the purpose of this regulation.

5. Margin against facilities. - (1) Following minimum margins shall be maintained against various facilities and all guarantees will be backed by 100% realizable securities:

(a)            In case of performance bonds, the condition of 100% cover of realizable securities may be relaxed subject to minimum compulsory realizable security cover equivalent to 20% of the amount of the performance bond;

(b)           In case of guarantees issued against mobilization advance, the condition of 100% cover of realizable securities may be relaxed subject to the following conditions, namely:

(i) Guarantees issued shall contain a clause that the mobilization advance shall be released by the beneficiary through the guarantor modaraba only; and

(ii) At the time of issuing such a guarantee the beneficiary shall sign an agreement with the modaraba that releases out of mobilization advance would be covered by realizable assets; and

(c)   In case of bid bonds issued on behalf of domestic consultancy firms bidding for international contracts where the consultancy fees are to be received in foreign exchange, the requirement of 100% cover by realizable securities may be waived off, and this relaxation would also be available to all suppliers of goods and services bidding against international tenders.

(2)       Modarabas shall adhere to the following margin requirements:

 

Page 7 of 28

6.          Facilities against Shares/TFCs and acquisition of shares. - (1)    Modarabas shall not:

a)                                        take exposure against the security of shares / TFCs issued by them.

b)                   provide   unsecured   credit   to finance subscription towards floatation of share capital and issue of TFCs.

c)                                        take exposure against the non-listed TFCs or the shares of companies not listed on the Stock Exchange(s).

d)                                       take exposure on any limited company against the shares/TFCs of that company or its group companies.

e)                                        take exposure against 'sponsor director's shares' (issued in their own name or in the name of their family members) of banks.

f)                                          take exposure against the shares/TFCs of listed companies that are not members of the Central Depository System.

g)                                       take exposure against unsecured TFCs or non-rated TFCs or TFCs rated below

h)                                       investment grade by a credit rating agency registered with the SEC.

 

2.                                         Modarabas shall not hold shares in any company whether as pledgee, mortgagee, of an amount exceeding 30% of the paid-up share capital of that company or 30% of their own paid-up fund and reserves, whichever is less.

3.                                         Exposure against the shares of listed companies shall be subject to minimum margin of 30% of their current market value, though the modarabas may, if they wish, set higher margin requirements keeping in view other factors. The modarabas will monitor the margin on at least weekly basis and will take appropriate action for top-up and sell-out on the basis of their Board of Directors' approved credit policy and pre-fact written authorization from the borrower enabling the modarabas to do this.

4.                                         Exposure against TFCs rated 'A' (or equivalent) and above by a credit rating agency registered with the SEC shall be subject to a minimum margin of 10% while the exposure against TFCs rated 'A-' and 'BBB' shall be subject to a minimum margin of 20%.

7.          Restrictions on certain types of transactions. - (1) No modaraba shall make investment in the shares of a listed company of an amount exceeding 5% of its own equity or 10% of paid up capital of that company whichever is less:

1.       Provided that these limits may be exceeded on an application made to the Registrar.

(2)                                    No investment in stock market shall be made by a modaraba except in its own name.

(3)                                    No modaraba shall allow facilities of any kind to its modaraba company or to any of its
directors or to individuals, firms or companies in which it or any of its directors is interested as
partner, director or guarantor, as the case may be, its chief executive and its major shareholders,
including their spouses, parents, and children or to firms and companies in which they are
interested as partners, directors or major shareholders of that concern.

(4)                 No modaraba shall allow unsecured facilities or facilities that are not backed by bank guarantees. Provided that the bank providing the guarantee shall have a minimum investment grade credit rating.

(5)                                    No modaraba shall allow facilities on the guarantee of its chief executive, directors and major shareholders including their spouses, parents and children or to firms and companies in which they are interested as partners, directors or major shareholders of that concern.

(5)                                     No modaraba shall allow facilities for speculative purposes.

(6)                                     Modarabas may make investment in shares of un-listed companies subject to fulfillment of the following conditions: -.

i)         total exposure in such companies does not exceed 5% of the modaraba's equity;

ii)        the directors of the modaraba company have no direct or indirect interest in the investee company; and iii)       the investee company must have operational track record of three profitable consecutive years preceding the decision:

Provided that where a modaraba is engaged in Venture Capital Financing as set out in its prospectus, this regulation may be waived on an application made to the Registrar.

(8)         The investment of modaraba fund in listed securities shall not be more than 20% of the equity of the modaraba. However, this restriction shall not apply where the modaraba has taken up the shares as consequence of underwriting obligation, or the modaraba became the absolute owner due to default of its borrowers.

Provided that in exceptional cases the Registrar may relax this condition.

(B)      Individuals Borrowers

8.         Regulations for Housing Finance for individuals

(1)                                     The maximum per party limit in respect of housing finance by the modarabas will be Rs.7.5 million.

(2)                                     Modarabas are free to extend mortgage loans for housing, for a period not exceeding twenty years. Modarabas should be mindful of their adequate asset liability matching.

(3)                                     The house financed by the modarabas shall be mortgaged in modaraba's favour by way of equitable or registered mortgage.

(4)                                     Modarabas shall either engage professional expertise or arrange sufficient training for their concerned officials to evaluate the property, assess the genuineness and integrity of the title documents, etc.

(5)