(Clarifies throughout not merger but transfer of management of funds)
By Bernardo Vizcaino
Nov 17 (Reuters) - Pakistan's Supreme Court has upheld a decision by the capital market regulator to transfer the management of two Islamic investment funds to Karachi-based KASB Modaraba, accelerating efforts to strengthen financing by investment partnerships.
On Friday, KASB Modaraba said it had taken management control of First Pak Modaraba and First Prudential Modaraba, a decision first taken in 2010 but challenged in the courts.
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.
The sector remains a tiny part of the country's Islamic finance industry, with several firms lacking scale to compete.
Last week, First Habib Bank Modaraba, a unit of Pakistan's largest lender HBL Bank, liquidated its business.
As of March, the three modarabas held a combined 1.9 billion rupees ($18.7 million) worth of assets, dwarfed by larger peers such as Standard Chartered Modaraba with 5.3 billion rupees in assets.
The Securities and Exchange Commission of Pakistan (SECP) has also developed risk management guidelines for modarabas, last year introducing sharia compliance and sharia audit mechanisms to strengthen the sector.
The equity-like nature of modarabas has left them vulnerable to market price swings, so the SECP issued rules in 2012 to allow smoothing of profits using a profit-equalisation reserve.
Pakistan's modaraba concept dates back to the 1980s as the first Islamic business model set up with a statutory framework and dedicated regulations, regarded as one of the purest forms of Islamic finance. (1 US dollar = 101.5500 Pakistani rupee) (Editing by Kim Coghill)