The initiation of the China-Pakistan Economic Corridor will require approximately Rs1.3 trillion from domestic sources for ancillary projects in addition to Chinese funding for directly related ventures.

This amount cannot be mobilised through sole reliance on the banking system where total credit to the private sector currently stands at Rs3.1tr. Consequently, the development of robust capital markets that complement rather than substitute bank financing is an essential pre-requisite for the successful implementation of the CPEC.

The ability to tap a heterogeneous investor base comprising asset management companies, insurance companies, pension and provident funds and high net worth individuals, provides issuers with much needed differentiation in funding sources away from traditional bank lines. This reduces pricing and increases tenor.

At the sovereign level, the Government of Pakistan remains the sole debt issuer. There is no issuance at the provincial government or municipal level to add diversity to sovereign instruments.

In addition, there is an acute shortage of sukuk issued by the government for investment by Islamic banks and windows.

The magnitude of this shortage which is estimated at over Rs400bn could impede the development of Islamic banking in the country and be a source of systemic risk for the economy.

Corporate issuance both in the form of TFCs and sukuk has also lagged behind other regional countries. Pakistan’s corporate debt as a percentage of its GDP currently stands at 2.4pc which is far below India at 22pc and Malaysia at 25pc.

A distinct lack of supply in primary markets is compounded by illiquidity in secondary markets which makes corporate debt virtually inaccessible to investors. Hence there is a dire need for reform at all levels.

Potential changes to the system must be approached holistically to address four main areas — (i) essential regulatory reform; (ii) increasing awareness amongst banks that act as arrangers for debt issues; (iii) enhancing issuer education about the benefits of debt issuance and (iv) much needed investor education about the benefits of investing in such securities.

Regulatory awareness needs to be increased at both the State Bank of Pakistan (SBP) and Securities and Exchange Commission of Pakistan (SECP) level and based on international best practice to effect meaningful reform. For starters, the SBP should allow issuance of unsecured, non-collateralised securities.

Enabling cash flow based investment will facilitate differentiation of bonafide debt capital market (DCM) products from traditional bank financings and incentivise issuers to come to market.

It must be realised that sukuk will comprise a majority of issuance in the country’s debt markets once the latter are fully developed.

Issuers will want to tap the entire pool of liquidity available amongst conventional and Islamic investors which would enable offerings to be most competitively priced as has happened in Malaysia.

Consequently, it is imperative that the SECP revise existing regulation in relation to sukuk issuance in order to create a level playing field with TFCs. Also, DCM regulation must be developed on a stand-alone basis rather than reverse engineered from equity capital market (ECM) regulation.

Banks acting as arrangers of debt issues also have a critical part to play in changing the system.

Rather than producing term sheets that simply replicate the usual conditions associated with bank syndications, there needs to be a drive to develop genuine DCM products which provide real disintermediation and diversification benefits for issuers. Such products could have non-amortising structures, be competitively priced in relation to bank funding and have longer tenors.

Issuers must be made aware of value and differentiation in DCM products vis-à-vis bank loans in order to be incentivised to issue. They should be encouraged to diversify their funding mix, utilising bank lines for working capital, short-term funding and project finance which often entails completion risk.

Issuers also need to be educated about the strategic advantages of a ‘debt initial public offering (IPO)’ which, much like equity issuance, should increase the public profile of the issuer. If regulatory processes are also streamlined, issuers will be strongly encouraged to create more supply.

Lead arrangers supported by regulators need to take the initiative in educating the non-bank, wholesale investor base.. It is a pre-requisite for thriving fixed income markets to have ‘real money’ fund managers that specialise in investing in debt based securities and provide retail investors with access to the product.

In order to develop a diverse investor base, it is also important that a range of products with varying risks and rewards are developed to satisfy the return requirements of investors. These attributes when combined with liquid secondary markets and tax incentives equivalent to equity investment in mutual funds should provide strong impetus to increasing demand for the product.

The evolution of debt capital markets is no longer optional but integral to the country’s continued economic development. Thus efforts at reform must begin now.

The writer is the head of Islamic Solutions, Merchant Banking Group, at Bank Alfalah

Published in Dawn, Economic & Business, April 10th, 2017