The Securities and Exchange Commission of Pakistan (SECP) is the apex regulator for Pakistan’s non-banking and finance sector. The scope of SECP regulations covers Islamic financial institutions, including Modaraba companies, Islamic mutual funds, Takaful operators, Islamic Non-Bank Financial Institutions (NBFI), Islamic Fintech, Sharia CompliantReal Estate Investment Trusts (REITs) and Sharia-compliant businesses.

The SECP also regulates Islamic capital market instruments such as Sharia-compliant listed securities, Sukuk, and Islamic commercial papers.

SECP has taken a proactive approach to support Islamic finance in recent years, resulting in several noteworthy accomplishments, including the issuance of Takaful rules and Sukuk-related regulations, the launch of the first Sharia-compliant Exchange Traded Fund (ETF), approval of the first Sharia-compliant developmental REIT, development of Islamic indexes at the Pakistani Stock Exchange etc.

To further support the industry’s need, SECP has also designated its officers as ‘Islamic Finance Champions’ to coordinate efforts across regulated sectors. In early 2023, SECP announced its regulatory sandbox for Islamic fintech firms to leverage technology promoting digital financial inclusion, Sharia-compliant products offering and digital intermediation in regulated Islamic financial services.

The Sukuk market is dominated by large players, and innovative ways such as tokenisation, fractionalisation, or ETFs need to be introduced for retail investors

The Sukuk market is dominated by large players, and innovative ways such as tokenisation, fractionalisation, or ETFs need to be introduced for retail investors

Early this year, SECP issued a very important Islamic finance diagnostic report to address challenges and promote the organised development of Islamic financial services.

The report aims to establish a comprehensive approach to propel the growth of Islamic finance in Pakistan, particularly after the government decides to eliminate interest from the economy and identified several policy areas for improvement and demands actions for creating a favourable legal and regulatory environment, fostering innovation in Sharia-compliant products, and serving underserved sectors for economic growth. The report also highlights key challenges and growth hindrances and aims to provide a roadmap to the industry.

At a wider landscape, SECP has identified industry-level issues that impact both the financial system and the development of capital markets in Pakistan, including the non-bank Islamic financial sector.

These issues include a large undocumented economy, a low savings rate due to interest-based saving products, limited use of the capital markets for financing by small and medium enterprises, a limited investor base, low public awareness, and a lack of trained human resources in Islamic finance.

Additionally, there is limited access to financial services in smaller cities, limited digital or online services, and low investor confidence due to non-Sharia-compliant product offerings and financial scams.

Analysis of the issues faced by the industry and the lack of public participation due to non-Sharia-compliant offerings has further strengthened the case of the Islamic finance sector as the right approach to solve the above issues.

There is a need for improved regulations and development of Islamic financial services, such as private funds, REITs, and non-bank microfinance companies.

The Sukuk market is dominated by large players, and innovative ways such as Sukuk tokenisation, fractionalisation, or ETFs need to be introduced to enable retail investors to participate.

The Takaful market is still in its formative stage, and technology can enable its growth. A focused approach is needed to enhance penetration in Pakistan, particularly targeting state insurers to concentrate and promote Takaful operations.

The Modaraba sector has potential for growth but lacks modern business practices and appropriate frameworks for new technologies. Enabling regulatory frameworks and platforms, such as Islamic equity crowdfunding and peer-to-peer financing, could help develop a more inclusive financial system. Fintech adoption would be highly beneficial for Islamic financial service providers.

When we review our securities markets in PSX, the majority of trading activity and assets under management at the Pakistan Stock Exchange are in Sharia-compliant companies, but there is little visibility of these segments to the world at large.

To attract more Sharia-conscious investors and stakeholders, it is important to recognise and effectively promote the Islamic capital market and develop a Sharia-compliant counter at PSX — a step that could easily double the active retail investor’s numbers in our markets.

Hence, to strengthen Islamic finance in a country and support the real economy, the role of Islamic finance in the non-bank financial sector will be important in mobilising private capital.

Policy actions are suggested to broaden avenues for capital formation and investment, deepen the financial market, and support the development of the real economy.

These policy actions include i) creating the Islamic Financial Services Act, a primary law to provide statutory cover for all regulated Islamic financial services in Pakistan, ii) introducing new Sharia-compliant investment products to meet the needs of stakeholders, iii) listing sovereign Sukuk and extending existing portfolios to retail investors through Sukuk tokenisation or fractionalisation iv) development of Sharia-compliant digital financing products and platforms.

SECP’s proactive approach is expected to boost the Islamic finance sector, attracting local and international investments and contributing to the growth and stability of Islamic finance in Pakistan.

Mr Siddiqui is Director, IBA, Centre for Excellence in Islamic Finance. Email: aasiddiqui@iba.edu.pk. Ms Jawad is a Research Associate, IBA Centre for Excellence in Islamic Finance.

Published in Dawn, The Business and Finance Weekly, August 14th, 2023