The Presidents/Chief Executives,
All Banks/DFIs

Dear Sirs/Madam,

 

ESTABLISHMENT OF SUBSIDIARIES / BROKERAGE
COMPANIES BY BANKS / DFIs

Please refer to BPD Circular No. 5 dated February 10, 2004 regarding Banks/DFIs intending to undertake brokerage business through subsidiaries and BPD Circular No. 7 dated March 8, 2004 regarding Banks/DFIs intending to establish subsidiaries for the purpose of diversification of their activities. It has been decided to consolidate and modify the instructions contained in the above mentioned Circulars for clarity. The following instructions in consolidated form will supersede the earlier instructions contained in BPD Circulars No. 5 and 7 of 2004.

1. The Banks/DFIs are required to establish separate subsidiaries if they wish to undertake asset management or conduct brokerage business. However they may at their own discretion, establish other subsidiaries as admissible under the law.

2. The Banks/DFIs desiring to establish any subsidiary shall obtain prior approval of State Bank of Pakistan. The application for the approval should contain the following information:
a. The functions and activities to be undertaken by the proposed subsidiary.

b. The investment to be made by the bank/DFI in the paid-up capital of the subsidiary.

c. The structure of the management and the Board of Directors of the subsidiary and the extent of bank’s / DFI’s involvement in the management and Board of Directors.

d. Any feasibility report, if prepared by the bank/DFI.

e. The interrelationship of the bank/DFI and the subsidiary covering the functions which will be performed by the bank/DFI for the subsidiary and vice versa.

3. The subsidiary can either be a public limited company or a private limited company.

4. The Board of Directors of the subsidiary should be completely independent and different from the Board of Directors of the Bank/DFI. The Bank/DFI may nominate its employees on the Board of Directors of the subsidiary up to 50% of the total directors, and the remaining directors nominated by the Bank/DFI should be independent individuals.

5. The Bank/DFI will fulfill all the other legal and regulatory requirements needed for the establishment of proposed subsidiary. In case of banks, it should be ensured that the subsidiaries are established only for activities as are admissible under Section 23 of the Banking Companies Ordinance, 1962.
a. In order to allow the subsidiary to take benefit of the brand name, the brand name of the bank/DFI is allowed to be used in the name of subsidiary. However, it shall be ensured that the word ‘Bank’ is not used in any manner in the name of the subsidiary.

b. Before commencement of business by the subsidiary, the bank/DFI will prepare written procedures for creating / building firewalls between the bank/DFI and the subsidiary. It will be ensured that the relationship is not used to access the confidential information of the customers / clients of the bank/DFI. Bank’s/DFI’s customers may, however, deposit money in the bank/DFI to be used as margin against trading through the subsidiary established for the purpose of conducting brokerage business.

6. The bank/DFI may provide support functions/services like human resource management, administration, accounting, information technology and other secretarial and general services for the subsidiary and share costs of overheads and fixed assets on predetermined terms and conditions. The premises of the bank/DFI may be utilized by the subsidiary, on an arms length basis and subject to the condition that both the bank/DFI and its subsidiary are made clearly and prominently identifiable through separate entrances, display of Boards and other means.

7. The banks/DFIs shall ensure that all the sale or support services performed by them or premises provided by them to the subsidiaries are on arms length and on commercial basis and appropriate fees are charged for these services. The bank/DFI will ensure that it is not assuming any sort of legal liability on behalf of its subsidiaries and its products. For this purpose, besides taking other necessary measures, the bank/DFI will also obtain professional legal opinion.

8. The bank/DFI may utilize their distribution channels for selling the products of the subsidiary. However, for this purpose, the bank/DFI will execute written agreement with the subsidiary. The agreement should interalia lay down the sales terms and conditions, features of the products to be sold by the bank/DFI on behalf of the subsidiary and fees to be charged by the bank/DFI for this purpose. The bank/DFI will take appropriate measures to disclose to the buyers of such products that they are buying the products of the subsidiary and not that of the bank/DFI and the bank/DFI is not guaranteeing or undertaking the repayment of any sort. The banks/DFIs should also ensure that the products offered by the subsidiary and distributed / sold by them do not resemble the products of the bank/DFI.

9. The Banks/DFIs shall take sufficient measures to ensure that the Bank/DFI is not exposed to risks, especially reputation and legal risks, on account of its subsidiary. For this purpose, it should be ensured that:
a. The transactions with the subsidiary should be conducted at arms length basis and appropriate fees should be charged for the services rendered by the Bank/DFI in this respect.

b. The Bank/DFI should avoid involvement in the day-to-day operations of the subsidiary.

c. Steps should be taken to make the customers/clients of the subsidiary aware that the subsidiary is an independent organization and it should not be construed as a part of the bank/DFI.

d. The Chief Executive, CFO and other employees of the subsidiary company shall not be in the employment of the Bank/DFI. A regularization period of six months i.e. up to 30th June 2005 is allowed in case of subsidiaries already established by the banks for undertaking brokerage business.

10. The banks/DFIs shall obtain prior approval of State Bank of Pakistan before increasing their investment in the equity of the subsidiary

11. It is clarified that the per party exposure limit proposed by regulation R-1 of Prudential Regulations for Corporate/Commercial Banking will be applicable on exposure to the subsidiary and any type of placement in the form of deposit, purchase of COI, certificates, units, etc. shall be considered part of the exposure of the Bank/DFI. Further, the exposure of the Bank/DFI on mutual funds launched/administered by the subsidiary shall also be considered exposure on the subsidiary.

12. The Non-Bank Finance Companies set-up as subsidiaries will be regulated by the SECP.

13. Following additional regulations are for Banks/DFIs intending to undertake brokerage business through subsidiaries:
a. In case, the members of the Board of Directors of the bank/DFI and their family members or employees of the bank/DFI and their family members wish to conduct sale and purchase of shares or securities or any other trading through the subsidiary, they will disclose all the transactions conducted through the subsidiary to the bank/DFI by submitting periodical statements on regular basis. The format of such reports and their periodicity may be determined by the banks/DFIs themselves.

b. The subsidiary will not undertake, either on its own or on behalf of its clients, sale and purchase of the shares of the bank/DFI or securities issued by the bank/DFI.

c. While it is expected that banks/DFIs would have instituted effective checks and balances and internal controls in their dealing rooms, deals conducted through their subsidiary should be monitored more closely. All deals of the bank/DFI conducted through the subsidiary must be made from designated fixed telephone lines installed in the dealing room and connected to a voice recording system. All trades of the bank/DFI executed through the subsidiary during the day, for which contracts and bills are received, must be matched with recorded conversations as well as all verbal orders given during the day, that have been taped, must be backed by contracts / bills at the end of the day to ensure that all deals have been properly taken into account.

d. The sale and purchase of shares and securities conducted through the subsidiary, in the first year of operations of the subsidiary, should not exceed 50% of the trading undertaken by the bank/DFI. In subsequent years, the trading through their own subsidiary should not exceed 25% of the total trading conducted by the bank/DFI. For the purpose of this regulation, the shares and securities will be valued at market rates.

e. The bank/DFI will not provide any non-fund based facility to the subsidiary. However, fund based facilities and margin financing may be provided by the bank/DFI to its subsidiaries under the relevant regulations of SBP and subject to the observance of Per Party Exposure Limit for fund-based exposure under Prudential Regulation R-1.

14. In case, it is found during the inspection or through other sources that the relationship (parent & subsidiary) has been used to structure a transaction or transactions to defeat the purposes of SBP regulations or banking laws, State Bank of Pakistan may, at its own discretion, direct the delinquent bank/DFI to dispose off / transfer its equity holding in the subsidiary within such time and in such manner as prescribed by State Bank and may also make a simultaneous request to SECP for the cancellation of the license of the subsidiary. This measure shall be without prejudice to any other action, which State Bank may take in this respect.

15. State Bank of Pakistan will closely monitor the situation on a continuous basis and if needed, the regulations may be modified from time to time.

16. It is clarified that the instructions contained in this circular are not applicable on the exchange companies established by the Banks in terms of FE Circular No. 9 of 30th July, 2002.

17. The above instructions will supersede the earlier instructions contained in BPD Circulars No. 5 and 7 of 2004.