“New policy gives the right signal to institutional investors”
Mubariz Siddiqui is a legal practitioner with extensive experience working with startups, venture capital funds, and angel investors in Pakistan. He frequently works with regulators on policy initiatives to facilitate foreign investment and innovative early-stage businesses in Pakistan. Currently he is the General Counsel at Sarmayacar, a Pakistan focused venture capital fund.
He has been practicing law since 2008. In his last position at Hub Power Company, Mubariz was the head of legal for two China Pakistan Economic Corridor power projects in Thar with a cumulative project cost of more than US$ 1 billion. Previously, Mubariz worked at RIAA Barker Gillette, and Orr Dignam & Co.
Following are the edited transcripts of a recent conversation BR Research with Mubariz that circled largely around the impact of liberalization of investment abroad regime:
BR Research: There has been a significant change in the regulatory ecosystem for startups with the liberalization of foreign exchange (investment abroad) regime. Could you tell us what the situation was like before in particular context of startups, and how the policy shift will impact the startup landscape?
Mubariz Siddiqui: The new changes to the investment abroad regime make it easier and enable a host of different cases: Pakistani companies to expand outside of Pakistan; stock options of foreign domiciled companies for employee’s resident in Pakistan; sweat equity directly in a company domiciled abroad; and for Pakistan resident founders to structure holding companies outside of Pakistan to raise investment from abroad.
To understand the importance of these changes, let’s consider the situation before these changes. In essence, Pakistani residents were restricted from owning equity (shares) in a company outside of Pakistan without the prior permission of State Bank of Pakistan (SBP). This approval could only be granted to a company, and not to an individual. This meant that Pakistani resident founders could not set up a holding company outside Pakistan to raise investment from abroad.
For context, most foreign institutional investors cannot invest directly in a Pakistani company. This is primarily because their mandates only allow them to invest in certain recognized jurisdictions (Singapore for example) because of comfort around tax treatment, dispute resolution, and other policies that have helped those jurisdictions establish a reputation for being investor friendly. Unfortunately, Pakistan is not among the preferred destinations or approved jurisdictions for global institutional venture capital / private equity firms. Hence Pakistani founders need to set up holding companies to raise investment from these funds.
The problem was compounded by the fact that these limitations only applied to Pakistani residents. Foreigners or non-residents Pakistanis were free to move back and start businesses in Pakistan using any holding company structure. As a result, we were in an untenable situation where Pakistani resident taxpayers were at a material disadvantage.
To address this problem, we needed a fundamental shift in the investment abroad policy by the SBP with approval from the federal government. Now a Pakistani resident is allowed to own equity in companies outside of Pakistan. For startups, the founders and early-stage investors are allowed to set up a holding company abroad in a jurisdiction that allows repatriation to Pakistan. This removes a significant regulatory barrier for foreign investors.
This policy was passed after consultations with stakeholders representing various industries across the board. As startups and VCs, we started engaging with SBP in November 2019 and were pleasantly surprised at the speed at which this was accomplished, given there was a pandemic and SBP also delivered on huge initiatives such as Roshan Digital Account and Raast. However, this would not have been possible without the leadership at SBP under Dr. Reza Baqir, which took the initiative to understand our concerns, and worked actively on formulating a policy that balances an important consideration around our foreign exchange reserves.
BRR: Does this make it easy for venture capital and private equity funds to invest in Pakistani startups? What kind of signal does it give?
MS: Absolutely. This new policy gives the right signal to institutional investors - venture capital and private equity firms - who are looking to invest in Pakistan. The message is very clear: The Government of Pakistan is serious about facilitating foreign investors. This would give them more confidence to invest in the country.
A more important signal is to entrepreneurs in Pakistan: the regulators will not get in the way of your legitimate ambition to build. Instead, they are taking major policy initiatives to facilitate that.
BRR: This paradigm shift should then also entice local investors, funds and VCs to invest in local startup space.
MS: Early-stage venture capital investment in startups is essentially an investment in the founders and hence is the riskiest asset class. Historically, people in Pakistan invest in assets (real estate, gold etc.). They do not invest in people. It is due to a casino economy that incentivizes rent seeking and disincentivizes risk. A weak judicial enforcement system further dissuades investment in people. I grew up in a socio-economic background where entrepreneurship was never really an option. Only those with access to capital – typically from wealthy families – pursued entrepreneurial ventures. Lack of capital has been the biggest hurdle for entrepreneurs and startups in Pakistan.
Policies that improve the Pakistani entrepreneur’s ability to access capital will reduce the risk for local investors. They can now invest in early-stage startups with increased confidence of availability of follow-on capital from institutional investors.
Another important development is that now the local investors have been allowed to invest in the local entity in Pakistan and in return get shareholding in the foreign holding company. This would ensure that the funds do not leave Pakistan while Pakistani investors do not miss out on.
BRR: Would this also help female startups because whatever little investment is raised by female business is usually from local investors, local VCs, and accelerators?
MS: Pakistan has very few VC funds; there are none who solely focus on female led startups and there are only a few that prioritize such investments. However, there are far more around the world that have a primary mandate to invest in women led businesses. With this change in policy, women entrepreneurs have access to far more funds.
So, while this policy change will help female entrepreneurs access more capital, we also need to incentivize more local seed stage funding for women led businesses.
BRR: This is definitely a major change in policy. But as you know, the ecosystem is an interplay of complex factors, and there are many other lingering issues that exists so far as attracting foreign equity in Pakistani firms. In the context of Doing Business rankings, Pakistan’s rank high up in protecting the minority shareholder, which is more than nullified by our poor ranking in contract enforcement. What in your view should be the next step to remove these irritants and bottlenecks?
MS: When you talk about policy to make it easier for Pakistanis to start businesses or that for attract foreign investment into Pakistan, it is not an on-and-off switch; it’s a continuous iterative process. While from a policy standpoint, this change in investment abroad regime is great; procedure and enforcement are equally important. The problem that we are foreseeing going forward is that SBP only deals with authorized dealers, which essentially are the banks. The procedure involved to take benefit of these policies is going to be undertaken by the banks.
The SBP has taken many initiatives; they have prepared an electronic system to monitor how effectively banks are processing applications, but the biggest problem is around a bank refusing to take me on as a customer to begin with. Currently if I don’t have a huge deposit with a bank, or have material influence over it, getting the bank take my case is an arduous task. This is something we will need to work on.
The good thing is that SBP is aware of this administrative and procedural challenge; and we are looking at ways to address it. That’s when I say that it’s an iterative process. Now that the federal government has approved a broad policy framework, the smaller procedural aspects can be handled by the SBP based on the issues encountered by applicants and can be addressed much quickly.
Venture capital is essentially always a minority stake in a company. So, there is no better signal or indication than being ranked high up in the minority protection category on a global ranking system, and it’s something we continue to highlight on global forums.
But when you talk about contract enforcement, it falls under the domain of the judiciary. Everyone is aware of the problems there. It is not an easy problem to solve. This problem is not restricted to startups or Pakistan either. Courts in most places across the world are not very efficient. However, in Pakistan even the enforcement of arbitral awards under the local law is not effective. This is solvable but would require changes to the legal framework around arbitration and enforcement of arbitral awards in Pakistan.
While I advocated fiercely for the Pakistani individual’s right to own equity outside the country (for reasons discussed above), my personal mission going forward is to work with the regulators to remove barriers that prevent foreign investors from directly making investments into Pakistan. This is not just a regulatory challenge. This is also a “Brand Pakistan” challenge. Trust and comfort are built over time. We can achieve this by creating, and consistently maintaining a regulatory framework as good as any globally recognized investment jurisdiction.
I am encouraged by the fact that the regulators such as SBP and SECP harbor a similar ambition. If we continue with this momentum, there is no reason why over the next few years Pakistan cannot be in the top 10 percent of the global Ease of Doing Business Rankings.