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February 10, 2021

SBP suggests amending forex exchange rules to assist startups


February 10, 2021

KARACHI: State Bank of Pakistan (SBP) has proposed changes to the existing foreign exchange regulations regarding borrowing from overseas in a bid to facilitate those fintech and startup companies that intend to invest in the form of convertible debt instead of directly as equity.

In a draft working paper posted on its website on Tuesday, the SBP called for a fresh look at a Chapter 19 of Foreign Exchange Manual. The central bank has proposed changes to the Manual after discussions with the representatives of the startups and venture capital firms over the last one year.

“A new type of loan may be introduced to meet the specific needs of startup companies keeping in view the issues they are facing in raising capital, in the form of convertible debt, from abroad under current regulations,” it said.

It has been observed that foreign investors, including venture capital (VC) and private equity funds and angel, are usually interested in investing in startups; however, keeping in view the financial risks associated with such ventures, at times, they prefer to provide funds initially as loan and subsequently decide about participation in the equity of the company, the SBP noted.

Startups also face funding issues due to unavailability of collateral/ security, which is a prerequisite by most of the lenders. However, VC firms and angel investors then try to cover the risk through alternate means. Thus, sometimes foreign investors charge premium for taking such risk, in the form of high return on loan amount or discount at the time of issuance of shares.

New paragraphs may be introduced in chapter 19 to facilitate the startup companies, the working paper revealed.

“A company may raise funds from abroad in the form of convertible debt i.e. the lender shall have the option to convert the loan into equity of the borrowing company, subject to the terms and conditions,” it added.

The borrowing company is incorporated as a private limited/public unlisted company under the Companies Act, 2017 (erstwhile Companies Ordinance 1984) for not more than 7 years, provided that such entity is not formed by splitting up, or reconstruction of a business already in existence.

The borrowing company has annual revenue below Rs2 billion since its incorporation. The borrowing company has equity (including retained earnings) below Rs300 million as per latest audited financials.

The SBP also suggested that the requirement of long-term credit rating would not be applicable.

In addition to the eligible lenders, funds can be raised from all those investors which are eligible for issuance of shares. The maturity of such loans shall range from one (1) year to five (5) years. The loans may be rolled-over subject to the condition that its total tenor will not exceed five years, in any case.

The SBP gives details about the maturity period and borrowing cost ceiling, which includes spread over relevant benchmark rate, loan related insurance premium, and other loan related fees payable in foreign currency; except the commitment fee, cost and expenses and fees payable in local currency.

As per the intended changes, funds borrowed can be credited in a foreign currency account opened and maintained in terms of Para 9(ii), Chapter 6 of the Foreign Exchange Manual.

The principal can be repaid in bullet payment on maturity and no prepayments would be allowed. The outstanding loan amount, including accrued profit/mark-up, can be converted into equity of the borrowing company on or before the maturity of the loan.

The borrowing company may issue shares in favour of the lender, in accordance with paragraph 6 and 7 of Chapter 20 of Foreign Exchange Manual. However, the shares cannot be issued below the latest break-up value as determined by the external auditors included in the category A of the State Bank’s approved list of auditors.