Participation Term Finance Certificates—Pakistan
4.2 Participation Term Finance Certificates—Pakistan
Another product that has been used in the capital market of Pakistan is Participation Term Finance Certificate (PTC). Whereby an investor shares in the profits of a business for a specified time through his investment. The initial experience with this product was not successful with respect to two aspects. First, certain conditions of PTC were not fully shari[ah compatible thus reducing its appeal to its purchasers. Second, taking advantage of weak regulatory and corporate governance environment a large number of issuers of PTC declared losses at the time of profit sharing.
However, a large business group operating in chemical industry issued a shari[ah compatible PTC in the form of Musharakah Term Finance Certificate (MTFC) with staggered profit sharing ratio and other features that proved very successful. The details of this product in given in Box-4 below.
Box-4 Case Study: Musharaka Term Finance Certificates
The Sitara Group, one of the high profile conglomerates in Pakistan formally decided to free its balance sheet from all conventional exposures and restructure its balance sheet in line with Shariah. Over the course of the last few years, the company issued two successful Musharaka based term finance certificates (MTFC) worth a total size of PKR 510 million (US$ 9 million). These were both privately placed and listed on the Karachi Stock Exchange.
The certificates carry a fixed tenor with profit payments linked to the operating profit or loss of the company. The profit sharing ratio has been structured in a slightly unconventional way. The level of yearly operating profit is divided into two broad categories under the heading of Level 1 Profit and level 2 Profit. Level 1 Profit is levied on the first PKR 100 million of operating profit that the company would make at a profit rate of 12% of the outstanding principal and Level 2 profit levied at 2% of the outstanding principal on each subsequent PKR 100 million operating profit.
The profit sharing ratio was worked back according to the projected profitability results of the company and the expected level of internal rate of return (IRR) that the company is willing to provide to the investors.
However, this at best remains expected since the actual IRR would depend on the actual profitability of the company, hence the analytical rigour in financial projections is key to structuring the profit sharing ratio at the outset. Semi annual profit is made on account payment (provisional) on the basis of projections irrespective of profit and loss and the final profit payment is determined on the basis of annual audited accounts of the company and adjustments made accordingly.
In the event of continuous dismal performance of the company, the investors risk losing their entire investment. That is, in case of genuine business losses, verified by the separately appointed auditors. Under such circumstances, the investors will have no recourse to the security, which is hypothecated in their favour, the call of which is only warranted in case of fraud and negligence proven in the banking court.
To mitigate the risk of loss for the MTFC holders, the company created and maintained a Takaful reserve, contributed both by the issuer and investor that run till the entirety of the issue. On the contrary, in case the company performed better than anticipated the potential IRR to the investors on their investment would be significantly higher than a comparative conventional fixed corporate bond of similar risk.
Source: Akbar, Salman. 2003. “Islamic Securitization-from a practitioner’s perspective” in BMA Quarterly Newsletter, October 2003, p.4-7.