August 11, 2007	Saturday	Rajab 26, 1428

ISLAMABAD, Aug 10: An international lender has pointed out serious policy distortions in the current stamp duties regime in Pakistan and said “it undermined the balanced development of the financial sector, increases the cost of corporate bond issues and lowers their competitiveness as compared with bank loans which are not taxed.”

The Asian Development Bank (ADB) has informed the government about the repercussions of the stamp duty on bonds with a maturity period of longer than two years.

According to ADB, the 1899 Stamp Duty Act gives provincial authorities the right to levy a stamp duty on term-finance certificates - corporate bonds. Until 2005, the duty rate was uniformly 0.15 per cent of the issued volume. In Punjab this rate was reduced to 0.05 per cent through the 2006 budget act.

However, the government of Punjab decided to levy the duty annually rather than just once. Now the rate is higher for bonds with a maturity longer than two years. The Sindh government only marginally reduced the duty for secondary issues while, Islamabad Capital Territory (ICT) had not changed the original rates from 0.15 per cent.

The ADB has highlighted this issue in its recommendations for the second generation reforms of the Pakistani capital market, which the bank is likely to fund in the near future. The ADB has been funding the financial sector reforms in Pakistan since 1995.

The stamp duty is a serious policy distortion. This is a key reason why the average amount of public corporate bond issues has been at around $20 million for years, which appears very high as compared with the size of typical investment projects in the country.

Smaller volumes are not competitive financially due to the stamp duty and other regulatory constraints that increase the cost of issuing bonds, the ADB has conveyed to the government.

“Annual levies clearly act as a disincentive for the issuance of long-term bonds. This significantly undermines the government’s objective to attract private sector participation in infrastructure, where long-term debt finance through bonds is particularly important,” the ADB says.

From a fiscal revenue perspective, the bank says, stamp duties on corporate bonds are insignificant given the small number of bonds issued - only six public bond issues in financial year 2006 for instance.

The ADB has pointed out loopholes in the overall Pakistani policy towards corporate bonds. It says the Securities and Exchange Commission of Pakistan (SECP) has not authorised trading in publicly offered corporate bonds outside the stock exchanges.

Instead, corporate bonds are required to be listed and traded within an electronic trading system established at the exchanges. This constrains bond market development, since it increases the cost of issuing bonds in the form of listing and rating fees without generating benefits.

As debt instruments, corporate bonds are typically bought by institutional investors instead of retail investors. Further, even in mature financial markets, bonds are typically held until maturity and traded only infrequently normally by phone through an informal over-the -counter market.

Therefore, forcing corporate bonds into listing and trading on a formal trading platform essentially designed for a listed share market with a large order flow from retail investors makes little sense.

Issuing corporate bonds involves cost in the form of registration fees and other charges that may be levied by the regulatory body. Moreover, the registration process takes time. The regulatory framework for bond issues should strike a balance between the public interest of investor protection, which is the key justification for regulation and the need to make bonds a competitive instrument for investment finance.

“Shelf-registration of bonds and equity, which helps to strike this balance, has been international practice for many years. However, securities market regulation in Pakistan does not support the concept of shelf registration. This significantly reduces the competitiveness of bonds as a means of investment finance,” the bank pointed out.