Term Finance Certificates (TFCs) in Pakistan

Term Finance Certificates (TFCs) are a common debt instrument used in Pakistan, similar to corporate bonds in other countries. They represent a form of Islamic finance, often structured to be Shariah-compliant, and are issued by companies to raise capital from investors. The funds obtained through TFC issuance are typically used for expansion, working capital, or refinancing existing debt.

Key Features of TFCs in Pakistan:

• Issuers: Primarily private sector companies, though sometimes government-owned entities issue TFCs. The issuer’s credit rating is a crucial factor for investors.
• Tenor: TFCs have a fixed tenor, or lifespan, which can range from a few months to several years, depending on the issuer’s needs and market conditions.
• Profit Rate (Coupon): Instead of interest, TFCs typically offer a profit rate that is usually benchmarked against a rate like KIBOR (Karachi Interbank Offered Rate) plus a spread. The profit is distributed to the investors on a predetermined schedule, such as quarterly or semi-annually. Shariah-compliant TFCs often structure the profit distribution using concepts like Musharaka (profit-sharing) or Ijarah (leasing).
• Security: TFCs can be secured or unsecured. Secured TFCs offer investors a claim on specific assets of the issuing company in case of default, providing an additional layer of protection. Unsecured TFCs are riskier, as investors’ claims are not backed by specific assets.
• Trading: TFCs are usually listed on the Pakistan Stock Exchange (PSX), allowing investors to buy and sell them in the secondary market before maturity. The price of a TFC on the secondary market fluctuates based on factors like prevailing interest rates, the issuer’s creditworthiness, and market sentiment.
• Shariah Compliance: Many TFCs are structured to comply with Shariah principles. This involves ensuring that the underlying activities of the issuer are permissible under Islamic law and that the profit distribution mechanism adheres to Shariah guidelines. These TFCs often have a Shariah advisor overseeing their structure.

Benefits of Investing in TFCs:

• Regular Income: TFCs provide investors with a steady stream of income through the periodic profit payments.
• Diversification: TFCs can help diversify an investment portfolio beyond equities and other asset classes.
• Potential for Capital Appreciation: If interest rates fall, the value of a TFC in the secondary market may increase, offering the potential for capital gains.

Risks Associated with TFCs:

• Credit Risk: The risk that the issuer may default on its profit payments or principal repayment. This is the most significant risk associated with TFCs.
• Interest Rate Risk: Changes in interest rates can affect the value of TFCs in the secondary market. If interest rates rise, the value of existing TFCs may decline.
• Liquidity Risk: While TFCs are listed on the PSX, liquidity can vary depending on the specific TFC and market conditions. It may be difficult to sell a TFC quickly at a desired price if there is limited trading volume.
• Inflation Risk: If the inflation rate rises above the profit rate of the TFC, the real return on investment may be eroded.

Conclusion:

TFCs offer a potentially attractive investment option in Pakistan, providing regular income and diversification benefits. However, investors need to carefully assess the risks associated with TFCs, particularly credit risk, and conduct thorough due diligence on the issuer before investing. Consulting with a financial advisor is also recommended to determine if TFCs are suitable for their individual investment goals and risk tolerance.