capital market development program in pakistan

8/2/2019 Capital Market Development Program in Pakistan

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ASIAN DEVELOPMENT BANKOperations Evaluation Department

PROGRAM PERFORMANCE EVALUATION REPORT

FOR

PAKISTAN

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


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Performance Evaluation Report

PPE: PAK 31108

Capital Market Development

Program

(Loans 1576-PAK and1577-PAK[SF])

in Pakistan

October 2005

Operations Evaluation Department

Asian Development Bank


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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 BankCDC Central Depository Company of PakistanCDNS Central Directorate of National SavingsCDS central depository systemCLA Corporate Law AuthorityCMDP Capital Market Development ProgramCOT carry-over transactionDSC defense savings certificateFMGP Financial (Nonbank) Markets and Governance ProgramICP Investment Corporation of PakistanIMF International Monetary Fund

IPO initial public offeringISE Islamabad Stock ExchangeKSE Karachi Stock ExchangeLAP Leasing Association of PakistanLSE Lahore Stock ExchangeMOC Ministry of CommerceMOF Ministry of FinanceMUFAP Mutual Fund Association of PakistanNBFC nonbanking finance companyNCC National Clearing Company of PakistanNCSS National Clearing and Settlement SystemNIC National Insurance Company LimitedNIT National Investment Trust LimitedNSS national savings schemeOEM operations evaluation missionOTC over-the-counterPCR program completion reportPIC Pakistan Insurance CorporationPPER program performance evaluation reportPRCL Pakistan Reinsurance Company LimitedRRP report and recommendation of the PresidentSECP Securities and Exchange Commission of PakistanSLR statutory liquidity ratioSRO self-regulatory organizationTA 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 MurrayDirector, Operations Evaluation Division 2 : David EdwardsEvaluation Team Leader : Tetsu Ito

Operations Evaluation Department, PE-667


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CONTENTS

Page

BASIC DATA iiiEXECUTIVE SUMMARY iv

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

II. PLANNING AND IMPLEMENTATION PERFORMANCE 4A. Formulation and Design 4B. Achievement of Program Measures 6

C. Cost and Scheduling 9D. Organization and Management 10

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

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

V. OVERALL ASSESSMENT 16A. Relevance 16B. Efficacy 17C. Efficiency 17D. Sustainability 17E. Institutional Development and Other Impacts 17F. Overall Program Rating 17G. 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 fieldworkundertaken by Yawer Sayeed and Asif Ali Qureshi (staff consultants). Barbara Palacios, seniorevaluation officer, and Vivien Ramos, evaluation officer, supported the team with researchassistance from Manila.

The guidelines formally adopted by the Operations Evaluation Department (OED) on avoidingconflict 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 personspreparing, reviewing, or approving this report.


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

APPENDIXES

1. Policy Matrix 222. Evaluation of TA Loan 1577-PAK(SF): Capacity Enhancement of the Securities 50

Market3. Statistical Data 56

Attachment: Management Response


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BASIC DATA

Program Preparation/Institution BuildingTANo.

Technical Assistance Name Type Person-Months

Amount($000)

ApprovalDate

2393 Capital Market Development ADTA 23.0 865 7 Sep 1995

2812 Interest Rate Management of National SavingsScheme ADTA 9.5 100 18 Jun 1997

2825 Capital Market and Insurance Law Reform ADTA 4.0 100 14 Jul 19972865 Restructuring of Public Sector Mutual Funds ADTA 32.0 800 15 Sep 19972866 Reform of the Insurance Industry ADTA 40.0 700 15 Sep 19972867 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 Loan1577-PAK(SF)

Loan 1576-PAK TA Loan1577-PAK(SF)

ADB Loan Amount/Utilization 250.0 5.0 250.0 3.6a

Key Dates Expected ActualLoan 1576-PAK TA Loan

1577-PAK(SF)Fact-Finding 418 Apr 1997 316 Apr 1997Appraisal 828 Jul 1997Loan Negotiations 2nd week, Sep 1997 1618 Sep 1997Board Approval 1st week, Nov 1997 6 Nov 1997Loan Agreement 5 Jan 1998 5 Jan 1998Loan Effectiveness 5 Apr 1998 5 Jan 1998First Disbursement 5 Apr 1998

b6 Jan 1998 27 Apr 1999

Second Disbursement 6 Jan 2000b

22 Jun 2000Loan Closing 31 Dec 2000 31 Oct 2001

c30 Jul 2002

Months (effectiveness to completion) 33 46 55

Borrower PakistanExecuting 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 52Fact-Finding 1 70Appraisal 1

d126

Project AdministrationContact Negotiations 1 37Inception 1 126Review 6

d179 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 millionbecause of fluctuation in the $/SDR exchange rate.

bFor Loan 1576-PAK.

cTo complete program implementation, the loan closing date was extended twice.

dFor Loan 1576-PAK and TA Loan 1577-PAK(SF).

eThe program completion report was prepared with no program completion mission.


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EXECUTIVE SUMMARY

On 6 November 1997, the Asian Development Bank (ADB) approved a loan of $250million from its ordinary capital resources to the Government of Pakistan for the Capital MarketDevelopment Program (CMDP). The CMDP aimed to accelerate the mobilization of long-termresources 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 enhancecompetition and a level playing field, (ii) strengthening securities market governance,institutions, regulation, and supervision; (iii) improving and modernizing the market infrastructureand promoting its integration; (iv) developing the corporate debt market; (v) reforming themutual fund industry; (vi) developing the leasing industry; and (vii) promoting contractualsavings through reforms of the insurance sector and pension and provident funds. The policymatrix of the CMDP included 58 program measures. Of these, 30 actions were already takenbefore Board approval, and 28 actions were to coincide with or precede the release of thesecond tranche (11 were the conditions for the release).

In conjunction with the CMDP, ADB approved a technical assistance (TA) loan of $5million equivalent from ADB Special Fund resources for the Capacity Enhancement of theSecurities Market (TA Loan 1577-PAK[SF]). The TA loan aimed to support the (i) institutionalstrengthening 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 wasdisbursed on 6 January 1998. The second tranche of the same amount was disbursed on 22June 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 monthslater than first planned. TA Loan 1577-PAK(SF) closed on 30 July 2002, 19 months later thanplanned. The program completion report (PCR), prepared in November 2002, rated the CMDPsuccessful.

The Operations Evaluation Mission (OEM) confirmed full compliance with 26 out of 30policy conditions that were to be met before the release of the first tranche. Of the remainingfour conditions, one had been partly complied with, one had not been complied with, whilecompliance with the other two conditions could not be verified. The OEM also confirmed fullcompliance with 20 out of the 28 conditions to be met by the time the second tranche wasreleased. 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 compliedwith. The PCR did not assess the status of CMDP conditions to be met before the release of thefirst tranche, but confirmed full compliance with 21 (75%) of the 28 remaining conditions.

In the OEMs assessment, the CMDP was highly relevant. The assessment was basedon the following observations: (i) the key implementing agency, i.e., SECP (the Corporate LawAuthority [CLA] at the time of loan approval), had taken ownership of the reforms and wassupported by a favorable political economy of decision making; (ii) ADB processing missionshad adequate knowledge and analysis of the country; (iii) ADB missions had extensive policydialogue with the agencies concerned and broad consultation with stakeholders, (iv) the


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program purpose was consistent with the countrys development priorities and the ADB countryand 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 thecountry; and (vi) the policy matrix was comprehensive, cohesive, and realistic, and it had amanageable number of appropriately sequenced program measures.

The OEM deemed the CMDP efficacious in view of the outcomes of the sevencomponents and the performance indicators. The OEM noted the satisfactory achievements ofthe four components concerning (i) competition and level playing field; (ii) securities marketgovernance, institutions, regulations, and supervision; (iii) securities market infrastructure; (iv)the leasing industry; and (v) the mutual fund industry. But, according to the OEM, theachievements of the corporate debt market component and the insurance and pension reformscomponent were only partly satisfactory. The missions assessment of the performanceindicators 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 sinceFY2003; (iii) market capitalization started to increase in FY2003, reflecting the rapid increase inthe index price; (iv) market infrastructure has been upgraded largely to the standardsrecommended 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) mutualfunds have increased in size since FY2003; and (vii) total premiums collected by general andlife insurance have progressively increased since FY1994.

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

as highly efficient.

The OEMs assessment is that most CMDP achievements are likely to be sustainable,considering (i) the Governments continued commitment to the program purpose, demonstratedthrough 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 thegrowing high-profile financial crimes and new forms of market manipulation as witnessed duringthe recent market upheavals. Based on lessons learned from this experience, SECP is furtherstrengthening 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, andempowerment of SECP as an independent oversight institution for the capital market andnonbank finance companies; (ii) the enhancement of accountability and improvement ofoperations of the stock exchanges; (iii) the establishment of the Central Depository Company ofPakistan and the National Clearing Company of Pakistan; (iv) the restructuring of theInvestment Corporation of Pakistan and the National Investment Trust Limited; and (v) thecorporatization of Pakistan Insurance Corporation and National Insurance Company Limited.However, the CMDP did not effectively support developing self-regulatory organizations in thecapital and financial markets. The stock market rally in recent years significantly contributed to


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job creation in the market industry, in the OEMs view, and to the broadening of the investorbase 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 thatTA outputs: (i) contributed marginally to the institutional strengthening of the SECP and theprivatization 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 partlysuccessful.

The OEM attributed the success of the CMDP to SECPs ownership of reforms,supported by a favorable political economy and effective policy dialogues. The key ingredientsof the effective dialogues were the following: (i) ADB processing missions knew enough aboutthe country because an economic and sector work mission had been fielded before thereconnaissance mission; (ii) the reconnaissance mission had extensive policy dialogue with

agencies concerned, especially CLA, and broad consultation with stakeholders; (iii) the policymatrix was drafted at an early stage of processing, and the Government took substantial actionsbefore loan approval; (iv) ADB processing and review missions made efforts to come up withalternative policy measures leading to realistic solutions while enhancing ownership of reforms;(v) one ADB processing mission member remained responsible for program implementationuntil the end, contributing to a close and constructive partnership; and (vi) ADB continued tomonitor unattained non-tranche program measures by extending the loan closing date. All theseare considered good practices for ADBs policy-based lending.

The establishment of workable self-regulatory market institutions was one of the fewunfulfilled items on the CMDP agenda. SECP believes that excessive autonomy granted toregional, mutualized stock exchanges may create self-interest clubs, and is therefore actively

pursuing demutualization before the exchanges self-regulation replaces some of the SECPsregulatory oversight. This approach could apply as well to other developing countries pursuingcapital market governance reforms in some cases, depending on the ownership andmanagement 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 wasgiven to TA Loan 1577-PAK(SF) in the PCR on CMDP. No separate project completion reportwas prepared for this TA loan. The OEMs review of the relevant project/program completion

reports suggested a general weakness in ADBs self-evaluation of TA loans attached to projector program loans.

Bruce MurrayDirector GeneralOperations Evaluation Department


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I. BACKGROUND

A. Rationale

1. In the early 1990s, the economy of Pakistan grew modestly but was characterized bybalance 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 supplyresponse, bringing the economy to the verge of a banking crisis in 1996. The economicinstability and institutional constraints of the capital market induced vulnerability in the KarachiStock Exchange (KSE) Index, which fell from around 2660 in March 1994 to 1332 on10 September 1996.

2. Citing economic mismanagement and corruption, the President of Pakistan dismissedformer Prime Minister Benazir Bhuttos administration in November 1996, dissolved parliament,and called for elections. In February 1997, the Pakistan Muslim League, headed by formerPrime 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 acomprehensive stabilization and structural adjustment program, including banking and capitalmarket reforms. In line with its country operational strategy for Pakistan of 1995,1 the AsianDevelopment Bank (ADB) was to support the capital market reform. This support was premisedon IMF and World Bank support for banking sector reform.2

3. The report and recommendation of the President (RRP) gave the following rationale forthe Capital Market Development Program (CMDP):3 The development of the securities marketwill facilitate the efficient allocation of resources in the economy and help broaden and deepenthe financial sector, while providing alternative sources of funding to industry, which hastraditionally relied on Government directed credit.

B. Formulation

4. In early 1997, the Government requested ADB to process the CMDP. Diagnostic studiesfor the CMDP relied on the findings of an economic and sector work mission from December1996 to January 1997, supplemented by outputs of a preceding technical assistance (TA)grant. 4 Following extensive policy dialogue with relevant Government agencies and broadconsultation with market participants, a reconnaissance mission in FebruaryMarch 1997determined the CMDP objective and components. A fact-finding mission in April 1997 reachedbroad consensus with the Government on the policy matrix, which included more than 40actions to be taken before the release of the first tranche. Substantial progress was made onthe prior actions. An appraisal mission was therefore fielded in July 1997 to fine-tune the policymatrix 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

1ADB. 1995. Country Operational Strategy Study for Pakistan. Manila.

2International Monetary Fund. 1997. Enhanced Structural Adjustment Facility; and World Bank. 1997. BankingSector Adjustment Loan.

3ADB. 1997. Report and Recommendation of the President to the Board of Directors on Proposed Loans to theIslamic Republic of Pakistan for the Capital Market Development Program. Manila (Loan 1576-PAK, for $250million and TA Loan 1577-PAK[SF], for $5 million, approved on 6 November 1997).

4ADB. 1995. Technical Assistance to the Islamic Republic of Pakistan forCapital Market Development. Manila (TA2393-PAK, for $865,000, approved on 7 September 1995).


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support operations in Pakistan. The loan negotiation for the CMDP was held in September1997.

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 andcompetitive capital market, which encourages broad-based participation of issuers andinvestors.5 The CMDP had seven components: (i) creating an enabling policy environment toenhance competition and a level playing field, (ii) strengthening securities market governance,institutions, regulation, and supervision; (iii) improving and modernizing the market infrastructureand promoting its integration; (iv) developing the corporate debt market; (v) reforming themutual fund industry; (vi) developing the leasing industry; and (vii) promoting contractualsavings through reforms of the insurance sector and pension and provident funds. The CMDPcomprised a total of 58 policy actions (Appendix 1)30 actions already taken before Boardapproval, and 28 actions to be taken by the time the second tranche was released (11 wereconditions for the release).

6. TA Loan 1577-PAK(SF) for Capacity Enhancement of the Securities Market was tosupport 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 capitalresources for the CMDP. Counterpart funds generated from this program loan were to be usedby 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 loaneffectiveness. The loan was to be disbursed in two equal tranches of $125 million each, the firstto be available upon loan effectiveness and the second after 2 years, as indicated in the policymatrix and the main text of the RRP. However, the program summary in the RRP indicated thatthe second tranche could be released within the 3-year program period. The Loan Agreementstipulated that the proceeds of the Loan are expected to be utilized by 31 December 1999while indicating the loan closing date to be 31 December 2000. The reason for this one-yeardiscrepancy 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 ofthe loan proceeds. MOF was to be supported by (i) SECP in overseeing and coordinating theimplementation 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 industryreforms.

5The Loan Agreement stated that the CMDP objective is to develop the Borrowers capital market by enhancinginvestor confidence and promoting a diversified, competitive and market-based capital market through, amongother things, appropriate regulatory and institutional reform.


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

11. To complement the CMDP, ADB also approved the following stand-alone TAs in JuneSeptember 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: Restructuringof 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 wasdisbursed on 6 January 1998. The second tranche of the same amount was disbursed on22 June 2000, 6 months later than originally scheduled. To allow monitoring of the progress ofunaccomplished 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 initiallyplanned. The program completion report (PCR)11 on both the CMDP and the TA loan wascirculated to the Board in November 2002.

13. The PCR rated the CMDP successful on the basis of the following: (i) the Program washighly relevant to the country and maintained its relevance during implementation; (ii) theProgram achieved definite results in key reform areas, e.g., modernization of the stock marketinfrastructure, establishment of SECP, and improved efficiency and enhanced accountability ofthe stock market; and (iii) CMDP outputs and outcomes were likely to be sustained. The PCRconfirmed full compliance with 51 policy requirements, substantial compliance with 2requirements, 12 and partial compliance with 3 requirements, 13 while considering 2 other

requirements14

inappropriate, in accordance with the opinion expressed by the consultant underTA Loan 1577-PAK(SF). The PCR recommended independently evaluating the CMDP within 3years.

6ADB. Technical Assistance to Pakistan for Interest Rate Management of National Saving Scheme. Manila (TA2812-PAK, for $100,000, approved on 18 June 1997).

7ADB. Technical Assistance to Pakistan for Capital Market and Insurance Law Reform. Manila (TA 2825-PAK, for$100,000, approved on 14 July 1997).

8ADB. 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).

9ADB. 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).

11ADB. 2002. Program Completion Report on the Capital Market Development Program (Loan 1576-PAK) andCapacity Enhancement of the Securities Market (TA Loan 1577-PAK[SF]) in Pakistan. Manila.

12These concerned (i) upgrading of corporate legislation (second-tranche condition), and (ii) improvement of creditadministration in the leasing industry (non-tranche condition).

13These concerned (i) establishment of NCSS (second-tranche condition), (ii) restructuring of mutual funds run bystate-owned investment companies (second-tranche condition), and (iii) upgrading of the Pakistan InsuranceInstitute (non-tranche condition).

14These concerned (i) development of the Mutual Fund Association of Pakistan and Leasing Association of Pakistanas self-regulatory organizations, and (ii) establishment of an OTC market for government and corporate debts.


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14. The PCR adequately assessed the CMDP outputs and outcomes. However, it did notdiscuss compliance with the conditions for the second tranche at the time of its actual release15and the appropriateness of ADBs disbursement decision. Moreover, the PCR did not includeenough information to allow an evaluation of TA Loan 1577-PAK(SF) and, hence, did not givean overall rating (para. 84).The PCRs 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 thesecondary bond market, were premature; and (iii) another component added in January 2000 tosupport 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, LahoreStock Exchange (LSE), Islamabad Stock Exchange (ISE), CDC, National Clearing Company ofPakistan (NCC), Leasing Association of Pakistan (LAP), and other agencies concerned and

market participants.16 This program performance evaluation report (PPER) incorporates OEMfindings, survey results, observations of ADB staff concerned, and a review of reports anddocuments related to the CMDP. The draft PPER was circulated to the Government and withinADB. 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 followingobservations: (i) the key implementing agency, i.e., SECP (Corporate Law Authority [CLA] at thetime of loan approval), had taken ownership of reforms and was supported by a favorablepolitical economy; (ii) ADB processing missions had adequate knowledge and analysis of thecountry; (iii) ADB missions had extensive policy dialogue with concerned agencies, especiallyCLA, 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, andthe Government took substantial actions18 before loan approval; and (v) ADB missions made

15ADB. 2000. Capital Market Development Program Progress Report: Release of Second Tranche. Manila. In thisreport, ADB confirmed compliance with eight conditions, substantial compliance with one, and partial compliancewith two.

16Before the OEM, the domestic consultant surveyed the outcomes of the CMDP through semi-structured interviewswith five reputed market players. OEM conducted interviews on the basis of the survey findings.

17ADB. 2003. Technical Assistance Performance Audit Report (TPAR) on Selected Advisory Technical Assistancefor Capital Market Development in Pakistan. Manila.

18The key policy actions included (i) reforms of taxes on equity transactions, (ii) relaxation of investment guidelines forinstitutional 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.


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

18. The OEM assessed the CMDP design as appropriate for the following reasons: (i) theprogram objective was consistent with the countrys development priorities and ADBs countryand 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 thecountry;21 (iii) the policy matrix was comprehensive, cohesive, and realistic, and consisted of amanageable number of appropriately sequenced program measures; (iv) the programframework identified workable performance indicators; (v) risk-mitigating measures based onadequate risk analysis were in place; (vi) the TA loan and grants provided were enough tosupport CMDP implementation; and (vii) CMDP was designed to complement the IMFsEnhanced Structural Adjustment Facility (ESAF) and the World Banks Banking SectorAdjustment Loan.

19. The OEM largely supported the policy matrix, with some reservations on two policymeasures: (i) self-regulation of market participants, and (ii) development of the corporate debtmarket. For the first item, the program measure for the release of the second tranche requiredthe SECP to set minimum criteria for granting a SRO status to stock exchanges. However, theSECP 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 tomaintain the SRO status. With such guidance, the SECP could have put more effort intopursuing this particular program measure. Another program measure related to the SRO statusfor the Mutual Fund Association of Pakistan (MUFAP) would have been meaningful only afterthe Government divested itself of its majority shareholding in the mutual fund industry. As to thecorporate debt market, CMDP included the following measure: market participants will developand 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 theexpected outcome.

20. TA Loan 1577-PAK(SF) was designed to support the agencies concerned in meeting theCMDP conditions for the second tranche that were not supported under previous stand-aloneTAs. Unlike the CMDP, the TA loan did not have a clear scope until the last phase of CMDPformulation, 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 whilethe proposed National Self-Regulatory Association (NSRA) provided on-site and continuous surveillance. At thesame time, however, ADB and CLA agreed to promote self-regulatory organization as an alternative to the creationof the NSRA. The Government pursued this alternative. Likewise, ADB was open to two policy options: (i) SECPoverseeing the securities market while creating a separate entity to supervise corporate affairs; or (ii) SECPoverseeing both the securities market and corporate affairs. The Government pursued the latter option.

20ADB. 1995. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to theIslamic Republic of Pakistan for the Financial Sector Intermediation Loan. Manila (Loan 1371-PAK, for $100 million,approved on 7 September 1995).

21In Pakistan, fiscal and external imbalances became unsustainable in 1996, resulting in an unprecedented decline inforeign exchange reserves to the equivalent of 2 weeks of imports in November 1996.


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B. Achievement of Program Measures

21. The OEM confirmed full compliance with 26 out of 30 policy conditions that were to bemet before the release of the first tranche. Of the remaining four conditions, one had been partlycomplied with, one had not been complied with, while compliance with the other two conditionscould 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 OEMcould not independently verify if the program conditions for the OTC debt market and thePakistan 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 policyconditions that were deemed partly complied with concerned (i) development of an OTC debtmarket, (ii) strengthening of the regulatory framework, and monitoring and inspection of mutualfunds, (iii) privatization of NITs mutual funds, (iv) reinforcement of lessors right ofrepossession, 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 stockexchanges, and (ii) granting of SRO status to MUFAP and LAP.

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

23. This component had several key policy achievements. It (i) relaxed investmentrestrictions for employee provident funds and life insurance companies, (ii) rationalized taxanomalies in the equity market, (iii) reformed the interest rate and tax structures of the nationalsavings scheme (NSS), 22 and (iv) rationalized the tax regime for mutual funds. Complementedby 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 investorswere barred from investing in the NSS.

24. Since CMDP implementation, NSS rates have been adjusted every 6 months since July2002 to align them with yields on market-traded Government bonds. The yield on 10-yeardefense 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 institutionresponsible for managing NSS, is being rationalized under the Financial (Nonbank) Markets andGovernance Program (FMGP).23

22Administered by CDNS of MOF, NSS is a source of nonbank financing for the fiscal deficit. There are variousschemes under NSS, but two major ones are 3-year special savings certificates (SSCs) with semiannual interestpayments and 10-year defense savings certificates with single payment of profit plus principal at maturity. Asidefrom being risk-free, NSS investments are on tap, and until March 2000 were also available to institutionalinvestors, which could benefit from higher-than-market returns and the tax-exempt status of the investments. TheseNSS peculiarities hampered the growth of both the banking system and the capital markets. As of June 2000, totalinvestment in NSS was PRs715 billion, equivalent to about 60% of all deposits in the banking sector.

23ADB. 2002. Report and Recommendation of the President to the Board of Directors on Proposed Loans andGuarantees 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).


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2. Strengthen Securities Market Governance, Institutions, Regulationsand Supervision

25. The promulgation of the SECP Act in December 1997 and the operationalization ofSECP in January 1999 were the key achievements of CMDP. The SECP Act gave operationaland financial autonomy to SECP in regulating the securities markets, nonbanking finance

companies (NBFCs), and corporate affairs by empowering it to administer the Securities andExchange Ordinance of 1969, Modaraba Companies (Floatation and Control) Ordinance of1980, and Companies Ordinance of 1984.

26. As envisaged under CMDP, the three stock exchanges (i) adjusted their board andmanagement structures,24 (ii) promoted the corporatization of member brokers, and(iii) createdinvestor protection funds. SECP issued most of the rules that the stock exchanges wererequired to adopt under CMDP. These were (i) trade reporting rules including penalties forinsider trading, (ii) inspection rules, (iii) licensing standards for traders and agents, (iv) listingrequirements and guidelines, and (v) model contractual agreements. SECP has not setminimum 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, therewas 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 OEMcould neither obtain a copy of this report nor verify SECPs response to it. The SECP, inconsultation with the industry, is now trying to decide whether a single SRO will suffice for allNBFCs or a separate SRO is needed for each licensed activity.

27. In recent years, SECPs Securities Markets Division has strengthened its enforcementfunction against insider trading and market manipulation. SECP also aims to phase out thedecades-old system of carry-over transactions (COTs),25 which permit excessive leveraging,and is encouraging its substitution with margin financing. Anotherkey follow-on measure beingpursued 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 ISEhave announced their plan to integrate.

24The number of directors on board of stock exchanges has been reduced from 18 to 10, half of whom (including themanaging 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 theexchanges are elected by the board from the elected directors. The operational and administrative activities of theexchanges are managed by the full-time chief executives, whose appointments are subject to the approval ofSECP.

25A COT is essentially financing for leveraged transactions in the form of a repurchase agreement with a few peculiarcharacteristics. There is a separate market session for COT financing through the same automated trading systemused 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 byselling the stock to the COT financier at the closing price of the stock. The borrower commits to buy back the stockat a higher price the next day but has the option to roll over the position daily for up to 10 days. COT financing is for100% of the share value without any margin. The difference between the purchase and sale prices is the return tothe COT financier. As COT financing session takes place after the close of the regular market, the borrower is notassured of COT financing at the time of trade and may need to arrange financing from some other source. Bothborrowers and financiers in the COT market transact through brokers. Those who provide COT financing arebanks, development finance institutions (DFIs), NBFCs, and individuals.

26SECP in February 2004 set up an expert committee, which released its report in October 2004 supporting thedemutualization and integration of all three stock exchanges. An alternative model that was considered involvedsetting up a new national stock exchange.


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3. Improve and Modernize the Securities Market Infrastructureand 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 firsttwo 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 areimplementing Internet-based trading systems. NCSS was fully operationalized in December2001. Delay in operationalization reflected the slower-than-expected implementation of TA Loan1577-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, withthe information technology, the only shared function still handled by CDC. NCC is nowmodifying its systems in preparation for the implementation of the margin financing module.

29. LSE and ISE recently announced their integration plan. KSE, which has reservationsabout 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 todevise 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 debtsecurities. Whereas (iii) was implemented, (ii) was not vigorously pursued during the CMDPperiod and OEM could not independently verify if (i) had been implemented. The consultingteam under TA Loan 1577-PAK(SF) concluded that an OTC debt market was prematureconsidering the level of capital market development in the country. Since CMDP implementation,however, trading, clearing, and settlement systems and procedures have been developed forstocks 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 arelisted on the OTC Board. In view of these developments after the CMDP, (ii) is consideredpartially complied with.

5. Reform the Mutual Fund Industry

31. As envisaged under this component, (i) SECP has been given regulatory control overpublic and private sector mutual funds through the SECP Act, and (ii) the updating of the policyframework has allowed the emergence of sector-specific funds and liberalized investmentrequirements, thus facilitating portfolio diversification. Moreover, the management rights of all 26funds of the state-owned Investment Corporation of Pakistan (ICP) were sold in three lots toprivate 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 meetingthis program requirement.

27KSE has increased the paid-up capital requirement for securities to be listed on its Ready Board from PRs50million to PRs200 million. This development should encourage small companies to seek a listing on the OTCmarket, where the minimum capital requirement is PRs10 million. The exchanges are now turning to leadingcorporate 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.


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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 andinspection capabilities, and (ii) privatization of mutual funds run by NIT. Those interviewed bythe OEM gave mixed feedback about the first measure. So far, SECP has made no on-siteinspection 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 somesub-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 isapproved by higher authority, the Privatization Commission will take the transaction to themarket.

6. Develop the Leasing Industry

33. Under this component the CMDP (i) transferred regulatory control of the leasing sectorto 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 tocollaborate with SECP to strengthen (i) industry standards for credit administration, pricing, and

portfolio and asset-liability management; and (ii) lessors right of repossession. However, asLAP did not take any substantial action, SECP addressed these issues instead in the prudentialregulations 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 theminimum paid-up capital requirement for insurance companies, and (ii) corporatization of thestate-owned National Insurance Company Limited (NIC) and Pakistan Insurance Corporation(PIC). In conjunction with the corporatization, PIC was renamed Pakistan ReinsuranceCompany 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 toestablish the Pakistan Insurance Regulatory Authority (PIRA) and instead assigned SECP toregulate the insurance industry through an amendment to the SECP Act. However, theoversight arrangement over the insurance industry remains unclear. SECP and MOC haveissued their own rules while SECP has neither significant enforcement powers nor the power torevoke licenses. Neither the Pakistan Insurance Institute nor the setting of industry standardshas been upgraded as envisaged under CMDP.

35. The implementation of TA 2867-PAK (footnote 10) was a key CMDP measure in thearea of pension and provident funds reform. However, according to the TA performance auditreport (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 assetallocation based on the age profile of participants. Under these rules, asset managementcompanies 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);


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(ii) increased cost of Government financing as a result of NSS rationalization and the relaxation ofinvestment 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 stockexchanges ($12 million); (vi) setup cost of NCSS and the OTC market ($10 million); and (vii) costof 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 consideredcofinancing of up to $250 million. However, this did not materialize. The OEM could not verifyeither the actual cost associated with the CMDP or the use of the counterpart fund generated outof 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 thanoriginally scheduled.28 The delayed program measures (as conditions for the release of thesecond tranche) concerned (i) capital market regulations and enforcement, (ii) operationalizationof NCSS, (iii) privatization of the mutual funds run by NIT and ICP, (iv) finalization of insurancelegislation, 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). Delayedimplementation 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) slowedprogress in (iv) and (v) (footnote 17). 29

D. Organization and Management

38. All the agencies concerned supported the CMDP objectives. MOF, the ExecutingAgency, rationalized the NSS. SECP played a pivotal role in capital market and NBFC reforms.KSE, ISE, and LSE undertook governance reforms and significantly upgraded theirinfrastructure. MOC was responsible for insurance legislation and corporatization of state-owned insurance companies. The Privatization Commission carried out technical work on theprivatization of ICPs and NITs 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 programperiod, ADB maintained adequate policy dialogue with the agencies concerned through sixreview missions and regular correspondence. One processing mission member remainedresponsible for program implementation almost until the end of the program period.Representatives of SECP acknowledged that the continuity in ADB staff assignment hadcontributed to maintaining a close and constructive partnership.

40. The OEM deemed appropriate ADBs assessment of compliance with the tranche andnon-tranche conditions by the release of the second tranche. By the time of release, eight of 11conditions tied to the disbursement had been fully complied with, one had been substantiallycomplied with,30 and the remaining two conditions had been partially complied with.31 The OEM

gave the following reasons to justify ADBs decision to release the second tranche: (i) ADB hadmaintained adequate policy dialogue with the agencies concerned on all the outstanding

28The 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.

29The TPAR (footnote 17) indicated the delayed completion of TA 2825-PAK by 16 months, TA 2865-PAK by 8months, and TA 2866-PAK by 13 months.

30This condition concerned capital market regulations and enforcement.

31These conditions concerned (i) the establishment of NCSS, and (ii) the privatization of the mutual funds of NIT andICP.


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program measures; and (ii) the three remaining measures tied to the tranche release were inprogress or under reconsideration. OEM also considered appropriate the extensions of theprogram period to allow the monitoring of unaccomplished non-tranche program measures.Most remaining items on the CMDP agenda (except privatization of NITs mutual funds) arebeing addressed under FMGP.

41. The RRP contained an inconsistency on the timeline for the release of the secondtranche as noted in para. 8. Since the program summary of the RRP indicated a less oneroustime frame than the 2 years envisaged in the policy matrix and the main text, the Governmentmay not have put in the full effort needed to implement the 11 program measures tied to therelease of the second tranche. Had the timeline been more consistently defined and closelymanaged, the Government might have implemented some of the program measures and TALoan 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 identifiedin the RRP. The OEMs assessment of the indicators is as follows: (i) the primary share markethas shown signs of recovery since FY2004,32 (ii) transactions in the secondary share markethave significantly increased since FY2003, (iii) market capitalization started to increase fromFY2003 reflecting a rapid increase in the index price, (iv) market infrastructure has beenupgraded largely to the standards recommended by the Group of Thirty Consultative Group onInternational Economic and Monetary Affairs, Inc. (G30) of the International Securities ServicesAssociation (ISSA), (v) the GDP share of investment in leasing assets remained within a rangeof 0.81.1% from FY1994 to FY2004, (vi) the total size of mutual funds has increased sinceFY2003, and (vii) total premiums collected by general and life insurance companies haveprogressively increased since FY1994. These performance indicators suggest largelysatisfactory progress in achieving the CMDP purpose. The ensuing paragraphs further

elaborate this finding.

Table 1: Key Statistical Data

Item Unit FY1994FY1996 FY1997FY2002 FY2003 FY2004

A. Performance Indicators of CMDP1. Number/Size of Equity IPOs 3759 08 2 10Number/Size

(PRs million) 3,20811,044 01,418 311 10,466

2. Average Daily Trading Volume Million shares 6.522.9 33.9192.7 214.4 387.1

3. Market Capitalization (at end of period) % of GDP 17.625.9 8.220.3 15.7 26.0

4. Compliance with G30Recommendations

8 of 9 conditions

complied witha

5. Total Investments in Lease Finance % of GDP 0.810.96 0.81.09 0.74 0.816. Total Mutual Funds Assets % of total

bankdeposits

1.473.33 2.90 4.32

7. Total Premiums Collected by GeneralInsurance Companies

PRs billion 6.79.1 9.415.3 19.6 22.0

32There was a surge in equity IPOs in FY1994FY1996. This was the period of large foreign portfolio investmentsfollowing the opening of equity markets to foreign investors in the early 1990s. The high domestic interest ratesduring these financial years made equity finance attractive.


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Item Unit FY1994FY1996 FY1997FY2002 FY2003 FY2004

8. Total Premiums Collected by LifeInsurance Companies

PRs billion 4.56.5 5.97.8 10.0 11.8

B. Memorandum Items1. KSE-100 (at end of period) 1,6072,331 8801,770 3,402 5,279

2. Equity Subscriptions Received PRs million 9,94940,739 01,134 1,193 46,470

3. Number/Size of TFC IPOs 02 117 21 3Number/Size(PRs million) 0175 502,250 2,025 400

4. Treasury Bill Yield: 6-Monthb

% 10.815.1 6.516.3 1.7 2.2

= not available, CMDP = Capital Market Development Program, G30 = Group of Thirty Consultative Group onInternational 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 forin 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 freshissues. 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 substantialreduction in interest rates, leading to a secondary stock market rally during this period. TheCMDP achievements, together with favorable macroeconomic and external conditions, alsocontributed to this rally.

44. Though market capitalization has grown significantly in recent years, the Governmentsshareholding still represents about 50% of the market capitalization33 of KSE-100. Moreover, theGovernment remains the largest raiser of funding through the primary equity market, comprisingmore than 60% of IPO value during FY2002FY2004,34 and there were also secondary offeringsand direct sale of shares of listed companies by the Government. IPO issuance by the privatesector 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 useof bank loans for their financing needs; (ii) the phaseout of the fiscal incentive of a lower tax ratefor listed companies with the unification of corporate tax rates; and (iii) stricter corporategovernance and reporting requirements for listed companies.

45. The Pakistan stock market experienced a major bullish run in early 2005. The KSE-100index, which surged by 65% from January 2005 to a peak of 10,303 on 15 March 2005, fell byabout 35% to 6,725 on 13 April 2005. To investigate this incident, SECP has immediatelyformed a task force, which submitted the report to SECP in June 2005. The report highlightedthe remaining weakness in market governance. On this basis, SECP has penalized severalstock 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 thesharp rise and subsequent drop of stock prices had been manipulated by a few large marketplayers. Some interviewees criticized SECP and SBP for not taking preemptive policy actions tocheck the accelerated rise in the market before it crashed. On the positive side, the KSEmanagement took credit for the fact that no broker had defaulted during the market crash; theirstringent risk management measures averted broker default, the KSE said. Against the 30

33OEM estimates based on stock prices as of 6 May 2005.

34This refers to the IPO of the Pakistan Oil and Gas Development Company Limited in 2003.


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March 2005 settlement of PRs30 billion, which was the highest single settlement in KSEshistory, 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 policyenvironment by increasing competition and creating a more level playing field. Intervieweesespecially acknowledged the following CMDP measures: (i) the easing of investment restrictionsfor employee provident funds and life insurance companies, (ii) the rationalization of taxanomalies 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, mostinterviewees considered the elimination of institutional investments in NSS, in place since March2000, as the most important contributory factor. Net investment in NSS increased from PRs37billion in FY1994 to PRs140 billion in FY1999 but declined to PRs257 million in FY2004 and hasshown 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 viewthat the creation of SECP was the main factor. Overall, the performance of this component wassatisfactory.

48. Off-sight inspection and investigations led the SECP in 2004 to (i) penalize brokers andsuspend 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 listedcompany for the improper dissemination of price-sensitive information; and (iii) impose a fine ofPRs535,000 on a financial institution for involvement in insider trading in the shares of a listedcompany (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 contactwith international firms for the purchase of a tailor-made market surveillance system, which willbe customized to suit local needs.

49. In the area of on-site inspection, SECP has started implementing a comprehensiveinspection 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, SECPhas fully implemented a risk-based methodology for selecting and setting examination and

inspection cycles for brokers and agents. These inspections have addressed the complianceproblems and system loopholes. SECP intends to inspect the operations of about 5% of themembers/brokers of each stock exchange yearly.

50. SECP has vigorously pursued institutional capacity building in response to claims fromsome market participants that its institutional development has not fully kept pace with marketdevelopments in recent years. In FY2003FY2004, SECP recruited 63 officers with expertise in

35NSS showed a net withdrawal of PRs8 billion in the first 8 months of FY2005 up to February 2005.


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chartered accountancy, business administration, law, and information technology. New staffincluded professionals with knowledge of market surveillance, inspection and brokerregistration, commodity exchange, and NBFC regulation. SECP employees have alsoundergone 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) MarginTrading Regulations of 2004, (iv) Property Trading Regulations of 2004, (v) Regulations forSystem 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 thesystem audit of brokerage houses. However, the stock exchanges still suffer from generallypoor public perceptions about their governance and transparency, and their self-regulatoryfunctions are weak. SECP believes that excessive autonomy granted to regional, mutualizedstock exchanges may create self-interest clubs, and is therefore actively pursuingdemutualization. Considering all these achievements and the SECPs ongoing efforts, theoverall performance of this component was satisfactory.

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

53. All the survey interviewees noted major improvements in market infrastructure. Theyacknowledged the significant contribution of the CMDP, and shared the view that automatedtrading had improved price transparency in order execution while CDS had reduced theincidence of fraud related to counterfeit shares in physical deliveries. The OEM believed that theimplementation of the margin financing module by NCC would contribute to further efficiencygains 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 FY2001FY2003 butdeclined substantially from FY2004 onward (Appendix 3, Table A3.2). Though these TFCs arelisted 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) madebank loans more attractive and, hence, were the key factor behind the decline in TFC issuance.In FY2003FY2004, PRs2.4 billion was raised in TFC IPOs versus a PRs386 billion increase inprivate sector borrowing from banks. As envisaged under the CMDP, SECP has approved thelisting of TFCs on the OTC market. SECP expects the trading of TFCs to make the corporatedebt market more vibrant, efficient, and liquid. Overall, the performance of this component waspartly satisfactory.

5. Reform the Mutual Fund Industry

55. The mutual fund industry has witnessed strong growth in recent years, reflected in theincreased participation of the private sector with the launch of new funds and the expansion inthe aggregate value of mutual funds (Appendix 3, Table A3.3). This growth was attributed partlyto the privatization of the closed-end mutual funds that used to be managed by ICP. As notedearlier, the finalization of the transaction structure for the privatization of the open-end mutualfund managed by NIT has been delayed. However, perhaps reflecting the expectation that thefund will be privatized soon, open-end funds have also grown in recent years. Most market


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participants interviewed by OEM considered the barring of institutional investment in NSS andthe buoyant equity market as major contributors to the growth in the size of the mutual fundindustry. Overall, except for the delay in the restructuring of NIT, the performance of thiscomponent was satisfactory.

6. Develop the Leasing Industry

56. Whereas the GDP share of leasing assets largely remained constant from FY1994 toFY2004 (Appendix 3, Table A3.6), leasing companies profitability has significantly improved inrecent years (Appendix 3, Table A3.5). The interviewees acknowledged the contribution ofCMDP 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 theregulatory responsibility for leasing from SBP to SECP has facilitated these developments.SECP has developed some capacity to effectively regulate the leasing industry by employingpeople from the industry. However, its capacity for on-site examination needs to be furtherstrengthened. 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 substantiallyincreased from PRs6.7 billion in 1994 to PRs22 billion in 2004 (Appendix 3, Table A3.4). From1996 to 2004, the number of general insurance companies fluctuated between 49 and 62, whilethe market share of NIC has been constant at around 1719%. The total gross premiumscollected by life insurance companies increased from PRs4.5 billion in 1994 to PRs11.8 billion in2004. During this period, the number of general insurance companies increased from three tofive, while the market share of State Life Insurance Corporation was progressively reduced from98% to 70%. OEM could not obtain the relevant quantitative data on pension and providentfunds. Despite the steady growth of the insurance industry in the last decade, surveyinterviewees 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 thecontinued 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 thepotential of the insurance and pension industry and expect further progress in reforms under theFMGP. Overall, the performance of this component was partly satisfactory.

C. Sustainability

58. Most policy achievements discussed in paras. 2335 appear to be sustainableconsidering (i) the Governments continued commitment to the program purpose demonstratedthrough 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 thegrowing high-profile financial crimes and new forms of market manipulation as witnessed duringthe recent market upheavals. Based on lessons learned from this experience, SECP is furtherstrengthening its surveillance function and enforcement of rules supported under the FMGP.


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D. Technical Assistance Loan

59. There was an inordinate delay of over 10 months in the recruitment of consultants for TALoan 1577-PAK(SF). The TA loan implementation was delayed further by the time-consumingconsensus building for the design and location of the NCSS. The loan closing date wasextended 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 hamperedthe evaluation of this TA loan. From the limited data available, the OEM came to the conclusionthat the TA outputs (i) contributed marginally to the institutional strengthening of SECP and theprivatization of state-owned mutual funds, (ii) contributed significantly to the establishment ofNCSS, and (iii) did not support the development of SROs and an OTC debt market. Overall, theTA loan contributed less than expected to CMDP and is therefore rated partly successful. Adetailed 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 ofSECP as an independent oversight institution for the capital market and NBFCs, (ii) theenhancement 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) thecorporatization of PIC and NIC. But CMDP did not effectively support the development of SROsin 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, PICcorporatization has not led to a reduction in staff strength. The survey results suggest that thestock market rally in recent years contributed significantly to job creation in the industry and tothe 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 takenownership 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 extensivepolicy dialogue with the agencies concerned and broad consultation with stakeholders; (iv) theprogram purpose was consistent with the countrys development priorities and the ADB countryand 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 thecountry; and (vi) the policy matrix was comprehensive, cohesive, and realistic, and had anappropriate number of program measures.


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B. Efficacy

63. The OEM confirmed full compliance with 46 out of the 58 policy conditions, andconsidered the outcomes of five (of the seven) CMDP components satisfactory. Thesecomponents 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 thecorporate debt market component were only partly satisfactory in the OEMs view. Theperformance indicators and other relevant data suggest largely satisfactory achievement of theCMDP 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 effectsrelative to costs met the expectations of the Government and stakeholders; and (ii) interagencycoordination, monitoring and reporting, policy dialogue, and ADBs disbursement decision at therelease of the second tranche releasethe various elements of program managementwereappropriate. OEM also considered appropriate the extensions of the program period to allow the

monitoring of unaccomplished program measures. SECP noted that continuity in staffassignment on the ADB side contributed to maintaining a close and constructive partnership. Ifthe associated TA loan had more effectively complemented program implementation, the CMDPcould have been assessed as highly efficient.

D. Sustainability

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

E. Institutional Development and Other Impacts

66. The OEM considered the organizational development and other impacts of the CMDPsignificant in view of the assessment presented in paras. 6061.

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 CDCall performed their expected roles under the CMDP, while coordinating with one another.SECPs ownership of reforms, supported by a favorable political economy of decision making,

was especially noteworthy. The OEM also noted (i) the Governments continued commitment tothe CMDP purpose demonstrated through follow-on policy actions, and (ii) stakeholders supportfor the CMDP achievement. From these observations, the OEM assessed the performance ofthe borrower as satisfactory.

69. ADBs performance in CMDP formulation and implementation was generally appropriateand associated with good practices (para. 79). Representatives of the relevant agenciesacknowledged the significance of policy dialogues with the ADB officers concerned, who had in-


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depth understanding of bottleneck issues that the country and its institutions faced. Given thisfeedback 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 bringingabout visible reforms in the capital market and corporate affairs. The current regulatoryarchitecture 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 increating 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 ofregulations and rules, especially through on-site examination. To effectively and efficientlyexercise this function, SECP should set up office in Karachi. This would also enhanceconsultation with market participants, possibly leading to a more market-friendly regulatory

environment. In pursuing good corporate governance and responsible market practices SECPmay also consider fixing the qualification criteria for market analysts and financial reportingstandards.

71. Stock exchanges significantly improved their operational efficiency and undertookgovernance reforms as envisaged under CMDP. However, a self-regulatory mechanism has notbeen effectively put in place. The OEM held the view that a workable and viable self-regulatoryframework presupposes demutualization to increase the accountability of the stock exchanges.Inherent conflicts of interest observed in regional, mutualized stock exchanges may threaten thebasic objective of ensuring a transparent and efficient market for investors. The OEM thereforesupported demutualization.

2. Regulation on NBFCs and the Insurance Industry

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

73. Several of those interviewed by OEM underscored the need to improve the policy andregulatory framework for mutual funds, by (i) streamlining the process of approving investmentschemes, (ii) formulating rules for specialized funds such as hedge funds and real investmenttrusts, 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 andstressed the need to license fund managers on the basis of appropriate criteria. Theinterviewees all believed that, despite growth in the size of mutual funds, the investor base hadnot broadened. Market participants traced this to the weak return performance of mutual fundsand the very small distribution network. Improvement in these areas would enhance the overallefficiency of the mutual fund industry.


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74. The oversight arrangement in the insurance industry remains unclear; SECP and MOChave issued their own rules but SECP has neither significant enforcement powers nor the powerto revoke licenses. This dichotomy has fueled uncertainty and weakened the ownership of theregulatory framework. SECPs exercise of its regulatory function is not made any easier. Fromthis perspective, the Government is considering transferring jurisdiction from MOC to MOF asan 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 FY2004FY2005, thesupply has been smaller than demand. Recent IPOs have been heavily oversubscribed as aresult. In terms of value, the listing of Government-owned entities has dominated fresh offeringswhile equity IPOs in the private sector have been relatively small. The capital market, it wouldseem, remains below its potential in mobilizing the resources of the non-state corporate sector.The OEM therefore supported SECPs recent initiative to assess the remaining impediments tothe development of the primary market.

4. Development of the Debt Market

76. While the NSS no longer corners investible funds from institutional investors, the debtmarket has not appeared to develop as a full substitute. The size of the corporate debt marketvis--vis private sector bank credit is very small, and secondary market liquidity is virtuallynonexistent. Though TFC issuance started picking up in FY2001, it declined in FY2004FY2005. Identifiable factors behind the slower-than-expected development of the corporate debtmarket include (i) high issuance costs associated with stamp duties, brokerage fees, bankcommissions, and prospectus publication and distribution, which become more prohibitive forshorter-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 OTCmarket 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 marketparticipants.

5. Level Playing Field

77. The rationalization of the NSS under the CMDP contributed significantly to a more levelplaying field across financial instruments. But there are still some distortions, such as (i) thesmall prepayment penalties on the premature withdrawal of investment in NSS, (ii) the capitalgains tax levied only on insurance companies, and (iii) zakat (religious levy) imposed on privatemutual funds but not on public sector funds. In relation to (i), the NSS instruments can beprematurely encashed at face value with the only penalty being a lower interest rate dependingon 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 ratesare much greater.

6. Market Irregularities

78. With technology, the risk of growing high-profile financial crimes and new forms ofmarket 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 manipulatedand syndicated activities of market participants. Apart from the market upheavals, market


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participants generally believe that market irregularities are still prevalent. SECP has recentlytaken punitive actions against specific instances of insider trading and price manipulation, butmonitoring and surveillance activities in this regard could stand further strengthening.

B. Lessons Identified

79. The OEM attributed the success of CMDP to SECPs ownership and leadership inreforms, supported by a favorable political economy and effective policy dialogues. The keyingredients of the effective dialogues were the following: (i) ADB processing missions gainedenough knowledge about the country from the economic and sector work mission that precededthe reconnaissance mission; (ii) the reconnaissance mission had extensive policy dialogues withthe agencies concern