Easing the regulatory bottlenecks for startups

February 14, 2021 (MLN): For the longest time, Pakistani startups, particularly fintechs, had been complaining about the regulatory landscape. The entire financial services industry – starting from the private players up to the very top, the two regulators – was marked by a bureaucracy typical of a rotten system. Starting from getting the prerequisite approvals to even set shop to going through months and years-long cycles at every stage of the process, it’s a needlessly tiring procedure. One that drains the already scarce resources available to young companies.

But now it seems like their prayers have at last been heard, that too from the most powerful stakeholder: the State Bank of Pakistan. For the last two years at least, the apex regulator had been dropping hints of liberalizing and more importantly, being willing to listen to new ideas. And come 2021, the change is visible.

To begin with, Raast was unveiled earlier in January with the promise of bringing some openness to the current financial services infrastructure. As an API-based system to be connected with all major banks, albeit amid a push from the SBP, it will make the process of integrating financial institutions far simpler as regulated fintechs no longer will need to individually onboard banks to build their own user base. That will take out the lengthy implementation time cycles. Admittedly, some details are yet to be ironed out, such as who will be running this infrastructure? Will we see a dedicated body such as the National Payments Corporation of India which looks after the United Payments Interface? That still has to be answered.

Even more recently, and significantly, the SBP amended the Foreign Exchange Regulations to allow Pakistani residents to have capital stakes in holding companies abroad. How does that change anything? Let’s try to understand the dynamics first. Globally, a sizable share of equity investments is routed through holding companies established in fiscally liberal countries or tax-havens. Unfortunately, Pakistan, due to the additional risks involved, hasn’t been much of a lucrative prospect for them. So even in the case, a local startup manages to convince an investor abroad to back them, it has to be routed through a holdco in a foreign land.

So far so good? Now the problem was that while the foreign investor could put the money in that holdco, the Pakistani resident founder of that startup was barred as the law sought the money trail of the funds because of which that stake existed in the first place. However, in the case of upstarts, that equity ownership exists not because of any funds invested but rather the employee stock options, which the law didn’t allow.

Under the newly amended regime, Pakistani founders will be able to have ownership in the foreign holding company of their own startup, which is expected to ease the process of raising investment easier.

Similarly, the new regulations have allowed export-oriented companies to set up subsidiaries abroad to expand operations. Previously, if an entity wanted to establish a branch in a foreign land, it needed permission from the SBP, which could take 6-12 months. Now that entire bureaucracy has been bypassed provided they meet a specified criterion for remittance.

Finally, the restriction levied on Pakistani residents regarding equity ownership in foreign companies has also been done with. That opens up the possibility for the countrymen to legitimately invest in international stock markets, for example, instead of sending money to that friend’s friend and risk getting ripped off. To be clear, this restriction is meant for small investors up to an amount of $25,000 a year, and cannot exceed 1% of the investee’s value.

Another change, currently in the draft stage, is being mulled in chapter 19 of the same manual, regarding introducing a specific category for allowing convertible debts as another possible investment instrument. However, considering how equity forms the bulk of the global funding landscape for start.

In any case, this is a major break away from the general policy of making sure any dollars held by Pakistanis don’t leave the country (that of course has a history of its own), which in turn channeled that outflow through non-banking routes. Now the stage is set for local startups to make sure all these initiatives don’t go in vain.

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