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May 6 (Reuters) - Pakistan regulators will introduce risk management guidelines for modarabas later this year, part of efforts to jump-start the equity-like financing format that remains a tiny part of the country's Islamic finance sector.
Modarabas are a form of Islamic investment partnership where assets are managed on behalf of clients, with income and expenses shared under a pre-agreed ratio, regarded as one of the purest forms of Islamic finance.
Pakistan's modaraba concept dates back to the 1980's as the first Islamic business model setup with a statutory framework and dedicated regulations, yet it has found limited interest while debt-based products have thrived in recent years.
Regulators are keen to change this: The Securities and Exchange Commission of Pakistan (SECP) has finalised risk management guidelines which will be circulated soon, Imran Hussain Minhas, joint registrar of the modaraba unit at the SECP, told Reuters.
"I cannot give the exact date of its official promulgation but hope to circulate it soon for implementation. It broadly covers all the business risks including the risk of sharia non-compliance, in addition we have also addressed the product-wise risks and their mitigation techniques."
He did not give specific details, but the guidelines would cover risks associated with common sharia-compliant contracts such as mudaraba, musharaka, murabaha, salam and istisna.
Last year, the SECP introduced sharia compliance and sharia audit mechanisms to strengthen the sector, and the new rules are expected to attract new firms.
"We have some applications for registration as MMC (modaraba management company) and expect one of them would be able to manage its IPO before June," Minhas said.
As of December, the sector included 26 firms operating 50 branches with total assets of 30.7 billion rupees ($310.6 million), SECP data showed, almost unchanged from a year ago.
The move comes at a time when authorities are stepping up efforts to develop Islamic finance, encouraging lenders to expand their operations in the world's second most populous Muslim nation.
Modarabas remain closely regulated. In Pakistan they hold the status of a corporate entity and must be listed on an exchange, which has further disclosure requirements.
But they are also quite flexible investment vehicles that can cater to almost any purpose, something the market should to capitalise on, said Muhammad Shoaib Ibrahim, chief executive of First Habib Modaraba.
Pakistani law allows modarabas to conduct multiple financing activities, trading of commodities, project financing, equity investments, as well as act as a special purpose vehicle and a venture capital company.
Modarabas can also be setup to offer a dependable source of medium-term financing, and the new rules would further help the sector become more uniform, Ibrahim said.
Further reforms to the non-bank financial sector are also underway which could spur further expansion, said Ibrahim.
Despite this, some modarabas haven't keep up with growth in the country's financial sector and some are even winding down.
In January, First Habib Bank Modaraba, a unit of Pakistan's largest lender HBL Bank, said it would liquidate its business. It did not give a reason but analysts pointed to a lack of scale of the business, with paid up capital of 397.1 million rupees at the end of September.
To an extent, their own equity-like nature makes modarabas vulnerable to market price swings, meaning some have been unable to remain consistently profitable.
For instance, First IBL Modaraba posted a profit of 9.3 million rupees for the year ending June 2013, a reversal from a loss of 41.5 million rupees a year earlier.
KASB Modaraba did the opposite, posting a loss of 46.1 million rupees in the year ending June 2013, compared to the 40.6 million rupees in profits a year earlier.
First Punjab Modaraba and Modaraba Al-Mali posted profits in two of the last six years.
This prompted the SECP to issue rules in 2012 that allow smoothing of profits using a profit-equalisation reserve.
But further reforms could be needed. Back in 2011, then central bank governor Ishrat Husain called for modarabas to diversify their products away from leasing business and for the lifting of their minimum capital requirements.
At the time, assets held by modarabas accounted for 0.2 percent of total assets held by the financial institutions, a figure which remains almost unchanged today. ($1 = 98.8250 Pakistani rupees) (Editing by Kim Coghill)