Financial Institutions (Secured Transactions) Act, 2016.

Background:

In a well-functioning credit market, a collateral registry allows borrowers to leverage their assets into
capital for investment and growth, and lenders to effectively enforce their interest in the secured
property, in the event of nonpayment. The legal regime must provide: (i) simple, unambiguous, low-cost
methods for creating security interests; (ii) a practical, effective, and sustainable means by which such
interest may be publicized within the market (so that other potential lenders can determine whether an
asset is already encumbered); (iii) a system for prioritizing competing claims between creditors; and (iv)
an effective system for enforcing lenders’ rights in the secured property in the event of default. Where a
secured transactions framework does not account for these requirements, creditors are reluctant to
lend and the market for credit is stymied. In respect of secured transactions, Pakistan’s legal regime
comprises of two substantively distinct legal frameworks: one for incorporated entities, and another for
unincorporated entities and natural persons. Corporate entities (i.e. public companies (listed or
unlisted), private companies, single member companies and companies limited by guarantee) can
presently avail of the registration system provided for in the Companies Act, to perfect security interests
over movable or immovable assets. Their ability to effectively collateralize both forms of assets ensures
their access to finance. However, unincorporated entities (i.e. business not incorporated under the
Companies Act) are by law excluded from the registration regime provided for in the Companies Act.
Whilst the Registration Act of 1908 (the “Registration Act”) does allow unincorporated entities to
register interests in both moveable and immovable property, said statute is primarily oriented towards
the registration of interests in immovable property. Registration is statutorily mandatory in the case of
rights relating to immovable property, and is a pre-requisite for effectiveness. However, as regards
moveable property, registration is not mandatory. Furthermore, the law is silent on the issue of priority
between competing written security interests. The effect is that the registration of interests in moveable
property pursuant to the Registration Act confers no additional protection to the ‘secured’ creditor.

Pakistani SMEs employ 78% of the work force, and contribute more than 30% of the nation’s gross
domestic product, 25% in export receipts and 35%in value addition in the manufacturing sector.14
notwithstanding their centrality to Pakistan’s economy, MSME financing needs remain largely unmet by
the formal financial sector. SMEs self-financing for approximately 89% of working capital and 75% of
their investment needs. These figures rise to 80% and 81% for microenterprises. Banks are only lending
to approximately 188,000 SME’s, or approximately 6% of the estimated 3.2 million SMEs in the country.
SME lending has declined since 2008. Advances to SMEs amounting to only 1.2% of GDP, and the ratio of
non-performing loans is relatively high, at 34%. The majority state owned SME Bank has almost stopped
extending new loans due to the ratio of non-performing loans (82%). The lack of MSME access to
financial services (especially regulated credit) has a substantial impact at all tiers of Pakistan’s economy
and society. MSME financial inclusion is therefore potentially transformative, in that it represents an
opportunity to simultaneously empower disadvantaged segments of society, integrate the economy,
foster inclusive growth, boost employment, mobilize untapped savings, raise tax revenues, and expand
the formal economy.
 OBJECTIVE & SCOPE OF THE ACT
The beginning of the ST Act states its purpose as follows:

“WHEREAS it is expedient for the promotion and conduct of banking business to provide for the creation
of security interests over movable property to secure the obligations owed by a customer to a financial
institution, clarify and expand for the purpose the meaning and scope of movable property, provide for
the establishment of a secured transactions registry, define, amend and codify certain laws relating to
security interests over movable property and provide for matters connected therewith or incidental
thereto.”.

The ST Act has been prepared on the basis of the ‘Legislative Guide on Secured Transactions’ prepared
by the United Nations Commission on International Trade Law (UNCITRAL), and following extensive
consultations with the World Bank and other stakeholders. With regard to its scope in terms of
borrowers, the ST Act applies to ‘Customers’, which term encompasses both: (i) Companies
incorporated under the Companies Act; and (ii) ‘Entities’, which term is defined in the ST Act to refer to
unincorporated entities, i.e. “a person other than a company, and includes a natural person, a sole
proprietorship, a partnership or association of persons, a nongovernment organization, a cooperative
society, a society, a trust and a body corporate established pursuant to a law.” With regard to lenders,
the ST Act is limited in scope to ‘Financial Institutions’ or a consortium of financial institutions, as
defined in the Financial Institutions (Recovery of Finance) Ordinance, 2001. The ST Act does not apply to
suppliers, or other types of lenders. Being Federal legislation, the scope of the Act is necessarily limited
to issues that fall within the purview of the Federal Legislature under the Constitution, of which
suppliers are not one. Certain types of security interests have also been excluded from the scope of the
Act, namely: security interests in any immovable property; book-entry security ; aircraft; ships/vessels.
The ST Act also does not apply to security interests created by operation of law (e.g. unpaid sellers’ lien,
bankers’ lien), save to the extent of determining priority. As discussed above, Pakistan’s legal regime
broadly comprises of two substantively distinct legal frameworks in respect of secured transactions: one
for incorporated entities, and another for unincorporated entities, including natural persons. Whilst
incorporated entities can avail of the Companies Registry to collateralize their movable assets,
unincorporated entities cannot, which substantially diminished the extent to which their assets could be
used to secure financing. The ST Act redresses this lacuna in financial infrastructure, by serving as a
comprehensive piece of legislation that provides unincorporated entities with a legal framework for
secured transactions. Being federally enacted, it provides for a centralized, uniform registry, in the form
of the ST Registry, which allows previously excluded natural persons, sole proprietorships, partnerships,
trusts, societies, and associations to register security interests over their moveable property. The law
does not affect the registration of security interests over movables by incorporated entities, which will
continue to utilize the Companies Registry. The ST Act provides for two means of by which a secured
creditor may enforce a security interest. The first is by filing a recovery suit under the Financial
Institutions (Recovery of Finances) Ordinance, 2001 (the “Recovery Ordinance”). The second is through
out of court enforcement. Globally, out of court enforcing mechanisms are of significant importance, as
they provide a way around what are often protracted, complex and risky litigation proceedings.
Conclusion:
The key objective of financial inclusion is to redress an inequality of substantive financial rights, between
the financially included and the financially excluded. The ST Act takes a key step in that direction, by
redressing an inequality in financial infrastructure that has specifically hampered the country’s MSME
sector. Through ST Act, unincorporated entities and natural persons have a secured transaction
framework that enables their access to regulated sources of finance.

The ST Act resolves many of the issues faced by MSMEs and unincorporated entities in this space, there
are a number of areas that may benefit from further attention. At the provincial level, the high levels of
stamp duty continue to present the most pressing obstacle to receivables based financing. Revisions or
even targeted exemptions to stamp duty can substantially ease access to finance for MSMEs. At the
Federal level, there are several issues that may warrant attention at this stage. Enabling the registration
of outright assignments within the ST Registry would extend the benefits of the secured transaction
regime to an additional mode of financing. Further, extending the ‘super priority’ rule beyond motor
vehicles, to other types of retention of title arrangement may allow MSMEs with another important
means of finance. The possibility of merging the ST Registry with the Company Registry may also be
considered. Businesses, typically MSMEs, often begin as unincorporated entities like sole proprietorships
and partnerships, and subsequently opt to become companies. A unified registry would obviate the
need for incorporating business to migrate their security registrations from the ST Registry to the
Companies Registry. Finally, in terms of judicial determinations, a resolution of the constitutionality of
out of court enforcements, in relation to both immovable and movable property, would improve the
quality of security for creditors, and thereby encourage lending, including to MSMEs.