Pakistan: Second Generation of Capital Market Reform Program

Finance / Money and capital markets

The impact of the proposed Program will be enhanced economic growth through a more efficient and balanced financial system. The Program_s outcome will be increased resource mobilization through the capital market for productive investment and employment generation by providing efficient savings vehicles for retail and institutional investors and diversify funding sources for enterprises. This diversification of funding sources will also make the corporate and financial sector more resilient to shocks.

The Program will: (i) support the development of institutional investors to facilitate long-term capital formation and increase the demand for securities, (ii) improve the efficiency of securities markets to increase the supply of corporate securities and optimize the allocation of financial resources into productive investment, and (iii) strengthen the governance of capital markets to improve market transparency and protect investors.

ADB has been supporting financial sector development in Pakistan since 1995 when the Financial Sector Intermediation Loan (FSIL) was approved. While this loan included a small capital market component (it focused on banking), only the Capital Market Development Program (CMDP), approved in 1997 together with a TA loan for capacity building, initiated comprehensive capital market reforms. CMDP was broad based and touched on all integral components of the capital market. According to its Performance Audit Report, CMDP was successfully implemented and produced concrete results. This included (i) establishment of SECP, (ii) modernized stock exchange infrastructure, (iii) full operationalization of automated trading and the central depositary system, (iv) establishment of a national clearing and settlement system, (v) liberalization of mutual fund investment policies and harmonization of taxation for private and state-owned mutual funds, and (vi) establishment of basic regulatory frameworks for insurance, leasing, and asset backed securities.

Building on the CMDP agenda, ADB approved the Financial (Nonbank) Markets and Governance Program (FMGP) in 2002. The Program consisted of a program loan, a political risk guarantee facility, and two TA loans aimed at strengthening (i) pension, insurance, and savings systems and (ii) regulation, enforcement, and governance of nonbank financial markets. Key achievements of FMGP include: (i) improved SECP capacity in the area of on-site and off-site inspections; (ii) establishment of regulatory frameworks for money markets and futures; (iii) strengthened disclosure and governance requirements for listed companies and nonbank financial institutions (iv) establishment of professional standards for accountants and auditors, (v) establishment of a legal framework for demutualization of stock exchanges (v) harmonization of the tax treatment of government and corporate bonds; and (vi) privatization of state-owned enterprises through the stock exchange. However, the FMGP had a number of complex amendments to financial sector laws, which have been considerably delayed, and covered a broad range of issues in various subsectors. The Government has proposed to ADB that the remaining amount under the second tranche of FMGP following release of the incentive tranche in September 2005 be cancelled, and key reform measures included under FMGP be pursued through the proposed Program. In line with the request, ADB cancelled the pending tranche of $80 million in May 2007. This approach takes into account the significant changes that occurred in the Pakistan's financial sector since FMPG was approved in 2002 and focused on addressing a smaller number of key binding constraints for capital market development. The Program supports a second generation of capital market reforms, building on key achievements made under CMDP and FMGP.

Enabling environment for private pension funds established

Development of domestic institutional investors supported

Corporate bond market development facilitated

Increased equity market breadth and reduced volatility

Institutional framework for sector supervision strengthened

Governance of securities markets, market professionals, and issuers strengthened