Types of FISFixed Income Securities are mostly bonds in the current market of the modernworld.
They can be classified into corporate and government bonds. Corporatebonds are issued by companies and organizations to fund debts and expansions etc.,they can further be classified as either investment grade or a non-investmentgrade bonds (also known as high yield bonds). Investment grades are issued bycompanies with a low default risk thus a lower interest rate whereas high yieldbonds have a very low credit rating due to a high probability of default. Government BondsSukkuk Sukukare types of fixed income securities which work in compliance with Shariah Law.Sukuk in the global market have usually been structured as trust certificatesbut there exist some jurisdictions that do not recognize the trust concept andhave opted for structuring Sukuks as participating notes under the legislationwhich in many ways is similar to the asset-backed securities. Types of SukkukTrustCertificates Inan ordinary or simple trust certificate transaction, the entity trying to raiseassets or funds establishes an offshore special-purpose vehicle (SPV) underappropriate law. The SPV which has been established than issues trustcertificates to investors and then utilizes the proceeds to setup an arrangementwith the entity obligated for funding purposes.
For the funding arrangementmentioned above the most used types of structures in a Islamic market include: ijara, murabaha and musharaka.· Ijara: a sale and leaseback structure· Murabaha: a trade finance· Musharak: an equity investment in the form of ajoint-venture AlternativeCivil-Law Structures Unlikethe trust certificate structure, alternative structures have begun to emerge inwhich the sukuk transactions are allowed to be carried out in compliance withthe local laws. This is usually achieved by the formation of asset-leasingcompanies which are setup in such a way to be able to issue certificates in theform of an ijara to investors which in turn allows the company to purchase theassets and subsequently lease them back to the obligators. This form of modelcan be compared with the loan participation notes which have been in the marketsince the previous century. Investors’Credit Exposure Intoday’s market most of the sukuk transactions have been structured in a way inwhich the obligator shares his credit risk with the investor. Nevertheless, theinvestors need to consider whether the sukuk only gives recourse to the obligoror to another separate entity represented by the assets dependent on the underlyingsukuk’s funding arrangement. Asset-basedvs Asset-backed Inthe asset-based structure of sukuk the reliance of the investors on the creditstrength of the obligor rather than the underlying asset which allows theobligor to simplify its reporting and segregation in relation to the assetssince they are aware of the fact that investors actually are only reliant onthe obligor’s credit strength.
Onthe other hand, in an asset-backed structure of sukuk the investor can beexpected to try and value the assets themselves as the return of capital andthe profit return in due course are based on the underlying assets themselvesrather than the obligor’s credit strength.A certificate of deposit (CD) CDis issued by a bank. In return for saving money with the bank, it pays interestto the account holder. CDs offer lower rates than bonds, but higher rates thantraditional savings accounts. Municipal bonds Theseare a type of government bonds, these are usually issued by states, cities, andcounties. These bonds also provide tax relief.Treasury-bonds Atype of a government bond; they usually are long maturity bonds (i.
e. 20years). The interest payments and principal repayments of the bonds are guaranteedby the government which issues these bonds to fund its debts.Othertypes of fixed income securities include Treasurybills, Treasury notes.
TheTreasury bills (T-bills) and Treasury notes (T-notes) are similar to the T-bond in that they are sold by thegovernment. The T-bill is ashort-term fixed income security that matures within one year from issuance,and typically sells at a discount to par. The Treasury notes have maturity dates of 10 years or less, and likeTreasury bonds, can be issued at a discount, at a premium, or at par.
T-bills: also known as Market treasury bills(MTBs) are Government Debt Securities with a maturity/tenureof one year or less. T-Bills are typically issued through the State Bank ofPakistan (SBP) with maturities of 3, 6 and 12 months. It is important to note thatT-Bills are discount securities. That is to say, they are issued at Below FaceValue and reclaimed at Face Value with no intervening interest payment. Insimple terms no coupon payments and sold at less than Face value of the bond. ”T-Billsare issued in the minimum denomination of PKR 5,000. T-Bill auctions are heldby the State Bank of Pakistan every fortnight. At present, outstanding T-Billsare approximately PKR 5.
8 trillion or 77% of total outstanding GovernmentSecurities” (http://jsgcl.com/pdf/KSE_Guideline_Book.pdf). These bonds are Purchased by individuals, institutions and corporate bodiesincluding banks irrespective of their residential status and primary dealermaintains a Subsidiary General LedgerAccount (SGLA) with SBP for thesettlement purpose.Pakistan Investment Bonds Governmentof Pakistan issued long term paper (FIBs) in 1992, with this came into beingthe long-term yield curve so the corporate enteritis to benchmark and issuetheir own long-term securities. The auction of FIBs was stopped in 1998 due toless response by the public on the declining earnings on these instruments. Atthat time, there was no long term marketable government security that couldmeet the investment needs of institutional investors.
The, government, in orderto develop the longer end of its debt market for creating a benchmark yieldcurve and to enhance the corporate debt market, decided to launch PakistanInvestment Bonds in December 2000. These Investment bonds are issued for tenures/maturities of 3,5, 7, 10, 15, 20and 30 years. However, at present, the Government is issuing bonds withmaturity of 3, 5 and 10 years only. PIBs are coupon bearing debt securities.
Theyare issued at face value and pay interest semiannual. A Primary Dealer maintains a Subsidiary General Ledger Account (SGLA) with SBP for the settlement purpose. They are purchased by individuals,institutions and corporate bodies including banks irrespective of theirresidential status. SBP & Ministry of Finance announce the coupon rates andthe target amounts after consulting each other.
”Current stock of outstanding PIBs is roughly PKR 1.3 trillion”. (http://jsgcl.com/pdf/KSE_Guideline_Book.pdf) PIBsare sold by the SBP to ten Primary Dealers through multiple price sealed bidsauction who get a commission on the sale proceeds of PIBs @ 0.5% on amount ofbid accepted or 3.5% of the target amount, whichever is less.
Here the tenprimary dealers:There is another selectionof government bonds, as various government owned and run companies issue their bonds.In 1988, Water and Power Development Authority (WAPDA), a government ownedstatuary company, issued a five-year bond. Over the period 1988 to 1994, WAPDAissued Rs. 22.5 billion of bonds to the public (Leonardo (2000)). Themarket experience of WAPDA bonds was disappointing due to two factors. First,WAPDA had to delay repayments of its maturing bonds due to insufficient funds.
Second, the secondary market for the WAPDA bonds did not meet marketexpectations due to the under capitalization of the market maker resulting inlow liquidity of the bonds. National saving schemeUnder the umbrella of National savings, A new bond has been launched this yearcalled the Premium prize bond, its majorcharacteristics are that the investment period in unlimited and not defined. Itpays out semiannual cash flows and no profit is payable if encashed before theeach of the six month periods. Zakat is exempted whereas the minimum investmentis 40,000 rupees, Individuals, private/public institutions and institutionalinvestors are also allowed to invest (funds such as pension, gratuity andtrusts etc.) Another recent addition to the scheme was a Short term saving certificate, Major characteristics include amaturity period of 3 months, 6 months and 12 months, basically anyone caninvest in them. It’s cash flows are received at the end of its maturity and noprofit is received if encashed before the maturity. Institutional investors arealso allowed and the certificate is also exempted from zakat.
Investment ProcedureInvestorPortfolio Securities Account InvestorPortfolio of Securities account is necessary for investing in PIBs, MTBs and GOPIjara Sukkuk. Primary Dealers/Scheduled Banks hold these securities in IPSaccounts on behalf of their customers. Customer is the legal owner of the securityheld in the IPS accounts with banks in accordance with instructions of SBP.
Detailsof the procedure are mentioned in a document attached. Corporate BondsTerm Finance Certificates TFCsare corporate debt instrument issued by financial institutions for short and medium-termloans. The financial institution involved basically acts as the trustee betweenthe other two parties involved, the issuer (borrower) and the investors. Someof the TFCs have fixed rate of returns while others have a floating rate whichincludes the risk-free benchmark + risk spread of the particular instrument.
All TFCs are rated before they are issued, by a rating agency based on the creditorhistory and the structure of the TFC. The two operating rating agencies inPakistan are JCR-VIS and PARCA.TFCscan be listed on any one of all of the stock markets in Pakistan for thepurpose of buying and selling. All the listed TFCs are traded through thelicensed members of the stock exchange on which they are listed on. Non-listedTFCs can also be sold/bought by direct negotiations with the buyer/seller,therefore they are less liquid so non-listed TFCs have a high liquidity riskare compared to listed TFCs.
Unlikebonds, TFC’s income is divided in the forms of coupons paid semiannuallytypically with the last coupon being paid at the time of the maturity. Thefaster recovery of cash flows makes the TFCs less risky are compared to thegeneric bonds where the lump sum amount is paid at the time of the maturity.Corporations are exempted from paying the withholding tax on TFCs but arerequired to pay the normal corporate tax on the income. The individualinvestors are required to pay a 10% withholding tax the time of the purchasewhich is then subsequently adjusted against the final tax liability during theassessments.The recent successfully subscribed debt issues of Standard Chartered Bank of 2 billion and so did KESC Azam Certificates for 2 billion,before the closing period, shows that demand for corporate debt is profound. Atthe same time, the domestic market witnessed innovation when Treet CorporationLimited announced to raise Rs1.255 billion through issuance of ParticipationTerm Certificate (PTC)PTCis a convertible and redeemable bond structure, which would not only deliver aninterest payment but also issue a predetermined number of shares till itsmaturity.
Detailsof the Listed TFCs, both public and private, are in a document attached. Commercial Papers Commercialpaper is a type of unsecured short-term debt issued by corporations. Commercialspapers came into being in Pakistan in order to help expand the money market byproviding an additional financial instrument to the investors. In Pakistan its deemeddesirable to diversify the short-term financing by issuing commercial papers asinstruments of redeemable capital under section 120 of Companies Ordinance,1984. Acommercial paper is issued for maturities between 30 days and one year and itsminimum size of issue cannot be less than ten million rupees. It is required tobe in the form of a promissory note and issued at such discount to face valuewhich is determined by the issuer in accordance with the existing T-Bill rates,KIBOR and its Credit Rating. Inorder to issue a commercial paper the issuer is required to appoint an advisorin the assistance on the structure of commercial issue.
An IPA needs toappointed for the sale of the issue on behalf of the customer. Detailsof the Listed Commercial Papers are in a document attached.