The outgoing fiscal year 2016 turned out to be quite eventful with respect to multiple developments in the capital markets. Pakistan has entered into a new era of equity trading after merger of all the three stock exchanges i.e. Karachi Stock Exchange, Lahore Stock Exchange and Islamabad Stock Exchange into a single Pakistan Stock Exchange (PSX) during current fiscal year. Also Morgan Stanley Capital International announced the reclassification of Pakistan into MSCI Emerging Markets Index (effective from May 2017) which was taken positively by the capital markets.
During the year Pakistan Stock Exchange (PSX) 100-Index reached 38,777 on June 17, 2016, the highest level in Pakistan stock market history (at that point in time). While continuing its upward momentum from the past three months, the benchmark KSE-100 Index gained 4.8 percent during June 2016 translating into a gain of 9.8 percent for the year.
On the economic front, Pakistan’s economy grew by 4.71 percent in fiscal year 2016 the highest rate in the past eight years. The growth was mainly driven by industrial sector, including automobile, fertilizers, chemicals, pharmaceuticals, rubber and cement. On the other hand positive factors such as greater energy availability, China-Pakistan Economic Corridor (CPEC) projects and other development projects are expected to boost the economy.
Inflation averaged 2.85 percent during fiscal year 2016 as opposed to 4.56 percent the previous year due to impact of low fuel cost on food and beverages and other product prices.
The economic growth remained broad based. According to provisional estimates the GDP growth during 2015-16 remained at 4.24 percent as compared to last year’s revised estimates of 4.03 percent. The total investment to GDP during fiscal year 2015-16 declined to 5.8 percent (Provisional Estimate) as compared to last year revised 15.12 percent during current fiscal year. Savings slightly improved to 14.6 percent of the GDP as compared to revised rate of savings to GDP of 14.5 percent.
The State Bank of Pakistan (SBP) borrowing requirements also remained relatively subdued compared to the last couple of years so the focus of investment managers and banks remained on booking higher yields in order to support their fixed income portfolio.
Given the outlook of subdued inflation in the short term and slightly high CPI growth towards the end of 2016 and start of 2017 it is expected that monetary policy rate will remain stable with a medium to low probability of rising by the mid of fiscal year 2017.
MUTUAL FUND INDUSTRY REVIEW
The financial year 2015-16 remained challenging for the Mutual Funds Industry. The assets under management slightly increased from PKR 443 billion on June 30, 2015 to PKR 490 billion as on June 30, 2016. During the year, 34 new open-end funds were launched up to June 30, 2016.
Equity funds (both Conventional and Shariah Compliant) dominated the AUMs of the industry with the largest share i.e. 39.35 percent.
Income funds (both Conventional and Shariah Compliant) held the second largest market share i.e. 28.21 percent, followed by Money Market funds (both Conventional and Shariah Compliant) with market share of 12.28 percent.
The Securities and Exchange Commission of Pakistan (SECP) notified the amendments in the Non Banking Finance Companies & Notified Entities Regulations on November 21, 2015. In light of strong determination of the SECP to promote ‘ease of doing business’ in all the areas under its ambit, SECP also amended the Non Banking Finance Companies (Establishment & Regulation) Rules, 2003 allowing asset management companies to obtain licenses to manage Real Estate Investment Trusts (REITS) and Private Equity Funds.
Mutual Funds Association of Pakistan (MUFAP) has been proactively involved in bringing transparency and good governance in the industry and we hope to continue this process with great vigour.
This year has been very challenging for the mutual fund industry with continued changes in the tax laws adversely affecting institutional investment in mutual funds. Declining interest rates and mostly bearish market conditions during the year under review further hindered growth of the mutual fund industry.
The mutual fund industry closed the financial year at PKR 490.37 billion up 10.57 percent over last year. The Equity Funds category (both Conventional and Shariah Compliant) constituted of PKR 178.17 billion up 12.17 percent from last year followed by income fund category at PKR 127.73 billion up 25.83 percent and Money Market category at PKR 55.58 billion which was down 30.67 percent from the previous year.
The Shariah-compliant funds category continued growing faster than the conventional category and closed the year at PKR 157.49 billion, recording the growth of 26.78 percent over the previous year.
A variety of mutual funds are being offered in this category to suit the varied needs of investors by asset management companies.
The present Board of MUFAP started its term on October 1, 2015. The Board had identified three key areas to focus on during the year which were as follows:
1. Making MUFAP independent and proactive
During the year conscious efforts were made to make the management of MUFAP more independent by enhancing the role of the Chief Executive in running the day to day affairs and restricting the role of the Chairman and Board of Directors to policy decision making.
This year various steps were taken to empower the Chief Executive, to make the institution stronger.
The CEO was the sole representative of MUFAP with the SECP and various Government agencies.
There has been significant improvement in the capacity building of the management team under the leadership of its Chief Executive.
2. Resolution of outstanding issues with FBR
Taxation issues have always been at the forefront every year and takes up majority of the time and effort of MUFAP’s Board and Management.
This year the two major issues taken up were charging of Federal Excise Duty (FED) on asset management services and the taxing of return of capital included in the dividend payment.
FED issue had major success on two fronts, the government finally accepted that the FED on services was leading to double taxation as the same was already being charged at the provincial level by the provinces and since it was a provincial matter after the 18th Amendment the government withdrew the FED on services already subject to provincial sales tax in the Finance Act 2016 effective from July 1, 2016.
In addition, in July 2016, the Sindh High Court also passed a judgment in the case filed by the asset management companies, striking down the Federal FED component which was the same as the Provincial law.
The FBR unfortunately is unwilling to accept this and has challenged the same in the Supreme Court even though the Federal Government’s position on the same is also clear with the removal of the FED on Services which are subject to provincial sales tax.
Therefore although the funds have stopped further provisioning from July 1, 2016, they will be unable to take a decision on the reversal before Supreme Court’s decision in the matter.
The issue pertaining to return of capital is still under discussions with SECP and FBR.
3. Element of income and its taxation/accounting treatment so the investors are not disadvantaged due to unjust taxes on return of their capital
Pursuant to the amendments that were brought in through the Finance Act 2014, mutual funds are now mandatorily required to make cash distribution to achieve the tax free status.
Due to this change, those investors who are investing later in the year are subjected to tax also on the portion of dividend that pertains to the portion of capital being returned to them (i.e. element of income received from them at the time of investment to equalize the dividend distribution).
An investor who invests nearer to June/dividend distribution date may only receive his capital back (his dividend would comprise only of the element of income he brought in), which should not be taxed, but at time of distribution since the dividend is distributed equally for all investors as cash on which tax is required by law to be withheld, resultantly their capital portion also gets taxed.
To come up for a solution for this matter so that the investors are not taxed unjustly, the MUFAP had formed a Committee to study the different jurisdictions and make recommendations accordingly to resolve this issue.
Internationally in most jurisdictions including the USA, varying dividends are paid to the investors based on the period of their investment.
MUFAP has worked extensively on this subject and after finalization has already submitted its recommendations to the SECP.
Resolution of this issue would address the tax anomalies for the mutual fund investors and help towards the growth of the mutual fund industry.
OUTSTANDING ISSUES WITH SECP
SECP had introduced amendments in Non-Banking Finance Companies and Notified Entities Regulations, 2008 on November 25, 2015 in consultation with MUFAP.
Most of the amendments introduced were in consultation except the following which MUFAP has taken up with the SECP:
I. Clause 38A. Responsibilities towards Corporate Governance and Proxy Voting.
Practically and operationally it will be very difficult for an asset management company to comply with requirements laid down in Rule 38A.
Also there is inherent confidentiality conflict as the results are to be disclosed in the annual reports of the CIS. Therefore it is proposed certain amendments in this clause to make it implementable.
II. Clause 58 (1) (k) Borrowing by CIS to meet redemption requests.
There are certain anomalies in this clause which can cause systematic risk to the Funds and MUFAP has proposed some amendments in the Regulation which are under discussion with SECP.
Significant Developments during the Year CGT regime for investors of open end mutual funds
The Finance Act 2016 has changed the withholding tax regime for capital gains tax (CGT) and authorized National Clearing Company of Pakistan Limited (NCCPL) as the withholding agent for open end mutual funds as well.
As a result, the unit holders of open end mutual funds would also be able to benefit from the netting regime across the capital markets, commodities and mutual fund industry.
NCCPL and MUFAP representatives are working on a proposed mechanism for the determination, computation, collection and deposit of CGT in a centralized manner.
CONVERSION OF MUFAP INTO SELF REGULATORY ORGANIZATION (SRO)
The SECP in September 2015 shared a concept paper wherein it proposed that MUFAP may be converted from trade organization to SRO, which will enhance the integrity and growth of industry.
The proposed SRO will play a proactive role for the development of Mutual Funds Industry and for the protection of Investors.
The SECP’s concept paper had listed the following as the possible areas/functions for the SRO:
1. Registration of members and mutual fund distributors
All NBFCs holding AMC/IA license shall be registered with the proposed SRO
2. Monitoring conduct of members and mutual fund distributors
Formulate set of rules and regulations to govern the conduct; Supervise to assess compliance with the rules and regulations
Take disciplinary measures against any misconduct and non-compliance
3. Promote investor education and awareness program
Support and sponsor educational programs, meetings and seminars to increase financial literacy and financial inclusion.
4. Research and development
Separate research and development function targeted at developing new products, improving risk management, evolving governance standards and achieving cost effective regulations.
5. Certification programs for members and mutual fund distributors
Conduct certification examinations to enhance the knowledge and educational standards of professionals.
The said concept paper has been discussed in great detail in various meetings at MUFAP’s Board.
The matter was also discussed in detail in the EOGM of MUFAP specifically held to discuss the proposal of SECP for SRO status for MUFAP on July 15, 2016.
The Members of MUFAP in the said EOGM have in principle approved the proposal of SECP for an SRO status for MUFAP subject to following conditions:
1. The member Asset Management Companies will not share any additional financial burden.
2. The Membership of SRO should be limited to mutual funds industry and the majority representation on the Board should be from AMCs. Independent directors should not be more than one third of the total composition of the Board and should have requisite knowledge of the mutual fund industry.
3. The SRO should have very well defined Terms of Reference (TORs) to be mutually agreed between SECP and MUFAP with the roles and responsibilities of SRO as front line regulator of mutual fund industry very clearly defined to ensure sufficient autonomy with SRO as well as avoid duplication of work.
The SRO should be evolved in a phased manner with the TORs containing the phase wise implementation steps along with pre defined timelines of the various areas to be covered by the SRO.
4. Sufficient resources should be allocated to SRO so that it is financially and administratively viable while maintaining independence.
Since SRO will assume some of the functions presently done by SECP, a portion of the fees generated by SECP from mutual fund industry should be allocated towards the SRO by amendments in the Regulations so that it has financial muscle for its capacity building and for meeting its day to day expenditure.
Initial funding is required at the time of setting up the SRO for its capacity building to be generated from sources other than asset management companies.
Also the possibility of setting up an endowment fund initially through funding from SECP or international donor agencies should be considered.
The Comments on the points mentioned in the concept paper were that monitoring of conduct of members is not areas are ready to even consider in the first phase.
Internationally also this is limited to compliance to the guidelines and standards made by the SRO and not the rules and regulations of the Regulator.
The remaining points MUFAP has been doing in its existing capacity as much as possible in its limited financial capacity which conversion into an SRO may not address if adequate funding is not available.
The future of the mutual fund industry is dependent on increasing awareness about the mutual fund industry and enhancing the outreach to investors across the country.
Over the past few years there has been gradual increase in the retail base which is presently around 34 percent. Asset management companies are offering a diversified range of mutual and pension funds to meet the risk appetite of investors, yet the awareness in the masses is lacking of the options available to them.
Asset management companies have started conducting awareness and marketing campaigns/road shows/seminars individually as well as from MUFAP and SECP’s platform. AMCs are also trying to enhance their distribution network. This will help in further enhancing the investor base of the mutual fund industry.