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Establishing Appropriate Institutional, Legal and Regulatory Frameworks: The evolution of Islamic finance regulatory framework and Shariah screening reform Kamarudin Hashim Securities Commission Malaysia 11 August 2014 Islamic Markets Programme (IMP)

Transcript of The evolution of Islamic finance regulatory framework and ...€¦ · The evolution of Islamic...

Page 1: The evolution of Islamic finance regulatory framework and ...€¦ · The evolution of Islamic finance regulatory framework and Shariah ... National Shariah Advisory Council . ...

Establishing Appropriate Institutional, Legal

and Regulatory Frameworks:

The evolution of Islamic finance regulatory framework

and Shariah screening reform

Kamarudin Hashim

Securities Commission Malaysia

11 August 2014

Islamic Markets Programme (IMP)

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Background – Malaysia’s Islamic finance agenda

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• Positioning Malaysia as a global hub for

Islamic finance products and services

• Islamic banking

• Takaful

• Islamic Capital Market (ICM)

• For ICM, key focus segment in the

market include Islamic equities, Sukuk

and Islamic fund management

Going beyond the

provision of an

alternative to

conventional finance

activities for issuers,

investors,

intermediaries and

other market players

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Islamic finance and capital market

PAKISTAN

• Banking

• Takaful

• Shariah stocks

• Mutual funds

BANGLADESH

• Banking

• Takaful

THAILAND

• Banking

PHILIPPINES

• Banking

BRUNEI

• Banking

• Takaful

• Mutual funds

• Stockbroking

SINGAPORE

• Banking

• Takaful

• Mutual funds

• Bonds

INDIA

• Mutual funds

SRI LANKA

• Takaful

• Mutual funds

INDONESIA

• Banking

• Takaful

• Shariah stocks

• Mutual funds

• Index

• Bonds

MALAYSIA

• Banking

• Takaful

• Shariah stocks

• Indices

• Mutual funds

• Bonds

• Stockbroking

• Islamic fund mgmt

ICM in M’sia has grown to RM1.6 trillion in Q2 2014 from RM294 billion in 2000 SC focuses on: • Developing a

comprehensive and facilitative framework

• Working closely with the industry to widen product range

• Developing linkages with other countries

• Driving thought leadership and capacity building

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Capital markets institutional framework in Malaysia

Listed Companies

Stockbroking Companies

Unit Trust Mgt Co

Investment Banks

MINISTER OF FINANCE

Fund Managers

PRS Distributors

Unit Trust Distributors

Banking/ Islamic banking

and insurance/ takaful sector

Private Pension Administrator

Securities Industry Dispute

Resolution Centre

SECURITIES COMMISSION BANK NEGARA MALAYSIA

FIMM

Bursa Malaysia

Attorney General’s Chambers

Companies Commission

Retail and Institutional Investors

e.g. Tabung Haji 4

Investor Education e.g. SIDC, INCEIF

CRAs BPA

Trustees

Invt. Advisers Financial planners

National Shariah Advisory Council

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Philosophy in developing Islamic finance regulatory framework

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Standards for Islamic finance regulatory framework should not be less than

conventional finance

• The regulatory framework for Islamic banking, Takaful and Islamic Capital

Market benchmarked against international standards and best practices

• Islamic finance products and services can

− leverage on existing regulatory infrastructure

− not compromise the universal goals of financial market regulations

• E.g. IOSCO Report of the ICM Taskforce 2004 and Analysis of IOSCO’s

Objectives and Principles of Securities Regulation for Islamic Securities 2008

− conventional regulatory framework applicable to Islamic capital market products and services

− Islamic capital market products and services may be introduced and developed within any existing well-structured securities market

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Regulatory outcome for Islamic finance remains consistent with the overall objectives and principles of financial market regulation

• In Malaysia, we have the whole spectrum for the Islamic finance regulation.

• To suit specific need of the market segment

• To realize Malaysia’s vision as the international centre for Islamic

finance

… that therefore seeks to achieve similar objective with

conventional regulatory framework

Although the form for Islamic finance regulation may differ

• Specific legislation e.g. Islamic Financial Services Act 2013

• Non specific legislation e.g. Capital Market and Services Act 2007, but

with certain provisions for Islamic capital markets

• Specific Guidelines e.g. Guidelines on Sukuk, Guidelines on Islamic

Fund Management

• Non specific Guidelines - Guidelines on the offering of Structured

Products, but with certain provisions for Islamic structured products

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Practical approach adopted for Islamic finance regulation

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In Malaysia, a 2-tier approach to Islamic Capital Market is being practised

Tier 1 Universal / General Regulatory

Requirements

Tier 2 Specific Shariah Requirements

Guidelines on the Offering of

Asset- Backed Securities

Guidelines on the Offering of

Structured Products

Guidelines on Unit Trust &

Wholesales Funds

Guidelines on ETF

Bonds - Trust deed, mandatory rating, eligible persons, etc

Unit Trust - Investment committees, trustees, management company, etc.

REITs - At least 75% investment in real property

Guidelines on Sukuk Guidelines on Islamic

REITs Guidelines of Islamic

Fund Management Guidelines and Best

Practices on Islamic Venture Capital

Sukuk - Shariah adviser, compliance with Shariah requirements, application of Shariah rulings

Islamic Unit Trust - Shariah adviser to certify that fund complies with Shariah requirement Islamic REITs - Tenants’ activities and rental income must comply with Shariah

requirement

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… with Shariah framework viewed as a fundamental

component within the overall regulatory framework

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• Two levels for Shariah governance

National based: Shariah Advisory Council - Bank Negara Malaysia

and SC

Market based : Shariah Supervisory Boards of Islamic Financial

Institutions

• Importance of Shariah governance

Ensure strict Shariah-compliance

Instill market confidence

• Increasing Shariah dialogue between national and market Shariah

experts as a platform to promote thought leadership and development

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Sukuk Issuers • Tax neutrality for sukuk transactions

Stamp duty exemptions

• Tax deduction on issuance cost for sukuk

Company setting up sukuk SPV also given tax

deduction

• Sukuk SPV not required to comply with

administrative matters under Income Tax Act

Investors

• Income tax exemptions for all residents on income

derived from non-RM investments

• No capital gains tax

• No withholding tax on income from RM and non-RM

investments

Intermediaries

• Tax exemptions on fees obtained from arranging,

underwriting and distribution of non-RM sukuk from

Malaysia

• Tax exemptions on profits received from the trading

of non-RM sukuk from Malaysia

Islamic funds Investors • No withholding tax

Islamic Fund Management Companies

• 10-year tax exemption on all fees received by fund

management companies for managing approved

Islamic funds for local and foreign investors up to

2016

MIFC promotion

• Additional/double tax deduction for promotion of

MIFC activities

Human capital

• Income tax exemption given to income received by

non-resident experts in Islamic Finance

Regulatory and tax framework to promote growth of ICM –

Malaysia’s case

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Sukuk

• Deemed approval (1-day) accorded for issues rated ‘AAA’ by local credit rating agency or for issues rated ‘BBB’ and above by a foreign credit rating agency

• Exemption from issuing a trust deed

• No restriction on use of international law in the offering documentation

• Opportunity to be listed on Bursa Malaysia - the top

sukuk listing destination in the world

• Foreign currency sukuk listed on Bursa and LFX that

meet certain criteria eligible to be included in

Bloomberg Malaysian Sukuk Ex-MYR Index

Islamic funds

Islamic Fund Management Companies

• Allowed to conduct foreign currency and ringgit fund management for retail and institutional investors

• Islamic fund management companies are allowed to invest all their Shariah funds abroad

• Up to 100% foreign equity ownership in the Islamic fund management companies

Investors

• Employees Provident Fund (EPF) has set aside a specific allocation of start-up fund for foreign Islamic fund management companies

• Bank Negara Malaysia (BNM) has also disbursed funds for Shariah equity investments and set up a developmental ‘Sukuk Investment Fund’ specifically for Islamic fund management companies

Human capital

• Expedited immigration approval through the ‘Green

Lane’ established for expatriates in Islamic Finance

and their family members.

Regulatory and tax framework to promote growth of ICM –

Malaysia’s case (cont’d)

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Shariah stock-screening

• List of Shariah compliant securities by SC’s

Shariah Advisory Council published twice a year

Regulatory and tax framework to promote growth of ICM –

Malaysia’s case (cont’d)

Government Investment Issue (GII)

• Long-term non-interest-bearing Government

securities based on Islamic principles issued by

the Government of Malaysia for funding

developmental expenditure

• Benchmark for Sukuk pricing

Sukuk

• Expenses for the issuance of AgroSukuk be given a double deduction for a period of four years effective from year of assessment 2013 to 2015.

• Framework on issuance of Socially Responsible Investment (SRI) sukuk being finalised, in response to global trend in issuances of green and social impact bonds to finance sustainable activities.

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Driving the growth of Islamic finance

• Both the public and private sectors have an important

role to play in developing the Islamic Finance market

• State of development of the financial market

• Need and sensitivity of the market

• In the early stages of development, Malaysia took the top

down approach

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Government plays a key role to support growth and development

Strong and consistent Government support is essential

MIFC, Capital Market Masterplan (CMP) and CMP 2, Financial Sector

Masterplan and Financial Sector Blueprint

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Shariah stock screening

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• Shariah stock screening refers to a process undertaken by the SC SAC that seeks to ensure securities of public listed companies (PLC) comply with the principles of shariah

• Each PLC is reviewed once a year based on the audited financial statements for

each financial year end and other relevant material

• The SAC issues a list of shariah-compliant stocks which are published by the SC in May and November of each year

• Companies seeking to list on the exchange may apply to undertake shariah screening to ascertain its shariah compliance. Pre-IPO screening is voluntary and is subject to a processing fee of RM10,000 + 5% of SC’s IPO fee with a maximum of RM50,000.

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Shariah stock screening – historical background

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• Pioneered in Malaysia by Bank Islam as they sought to identify “permissible counters for investment” by reviewing the activities of companies listed on the then KLSE

• A national level screening methodology was first developed in 1995 by the SC through the work of ICM unit and Islamic Instrument Study Group (IISG)

• Publication of the list of shariah-compliant securities began in 1997 following the formation of SC’s SAC in 1996

• Revised screening methodology announced by the SC in 2012 and implemented in November 2013

• Publication of methodology and list of shariah-compliant securities allows scale and

growth of shariah-compliant equity and investment management segments and expansion on Islamic capital markets’ international reach outlined in CMP2

• List of shariah-compliant securities forms the basis for Bursa’s Shariah indices, as well as investable securities for Islamic funds, ETFs, structured products etc.

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Shariah stock screening – milestones

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Pre-1993

• Shariah screening pioneered by Bank Islam

1995 • Development of shariah screening criteria to facilitate compliance review

process undertaken by SC’s ICM unit and Islamic Instrument Study Group (IISG)

1996 • Establishment of the Shariah Advisory Council of SC

1997 • The SAC announced the official list of shariah compliant securities

1999 • Bursa Malaysia launched the Kuala Lumpur Shariah index

2004 • The SC disclosed the benchmarks applied in the screening of shariah

compliant securities

2004 • Shariah compliant review at pre-initial public offering stage undertaken by the

SAC upon application by issuers

2007 • Bursa Malaysia and FTSE launched 2 Shariah indices - (i) FBM EMAS Shariah

Index and (ii) FBM Hijrah Shariah index

2012 • The SC announced the revised screening methodology

2013 • Revised screening methodology made effective in November

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The SAC provides a national level shariah compliance review

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• Facilitates efforts to promote centralisation and harmonisation of shariah decisions on

the status of listed stocks • SC’s regulatory mandate also allows for the issuance of relevant guidelines on shariah

compliance e.g. guidelines on disposal of non-compliant stocks

• Enhances market confidence as the stocks are endorsed by the shariah body at the national level

• SC has appointed scholars, academicians and practitioners from diverse backgrounds for membership of the SAC to accommodate broad perspectives on Islamic jurisprudence

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Revised stock screening methodology – November 2013

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Stock screening involves both quantitative and qualitative assessments: 1. Quantitative assessment

I. Contribution from shariah non-compliant activities (computed and compared with group revenue and the group profit before tax) must be below predetermined thresholds

II. Financial ratio benchmark - shariah non-compliant cash and debt must be below a predetermined percentage of total assets (i.e. 33%)

2. Qualitative assessment

I. Public perception and image of the company is assessed

The listed security must pass screening at both stages in order to qualify as shariah-compliant

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Revised vs. previous screening methodology

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The revised screening methodology introduces financial ratio benchmarks, in addition to the business activity benchmarks of the previous methodology

Quantitative assessment • Business contribution

thresholds: • 5% • 10% • 20% • 25%

Quantitative assessment • Business contribution

thresholds: • 5% • 20%

• Financial ratio benchmark: • 33%

Previous methodology Revised methodology

Qualitative assessment Qualitative assessment

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Impact of revised screening methodology

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817

650

923 911

Dec-2012 Dec-2013

Number of Shariah-compliant Securities

Shariah-compliant

Total listed securities

942 1030

1466

1702

Dec-2012 Dec-2013

Market Cap of Shariah-complaint Securities (RM bil)

Shariah-compliant

Total Market Cap

• Revised screening methodology reduced the number of shariah-compliant securities – however market capitalisation as a whole was not severely impacted

• Despite the contraction in numbers, shariah-compliant securities continue to experience robust growth.

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

% Growth FBM EMAS vs. FBM EMAS Shariah

FBM EMAS Shariah FBM EMAS

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Guidance on disposal of shariah non-compliant securities

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Within six months of effective date Six months after effective date

Price = or > investment cost (Breakeven/Net

profit)

Price < investment cost (Net loss)

Price > investment cost (Net profit)

Price < investment cost (Net loss)

• Must liquidate holdings within six months

• Any dividends received and capital gain from disposal can be kept by investors

• May hold until price of securities equal or exceeds investment cost

• Dividends received can

be used to expedite disposal

• Allowed to subscribe to/receive any new issue of securities by the company e.g. rights, special, bonus to expedite disposal

• Liquidate immediately

• Profit (dividends received prior to and difference between investment cost and the closing price on the announcement date of the latest list) can be kept

• Excess profit (dividends received after and difference between disposal price and closing price of announcement date) channeled to baitulmal and/or charitable bodies

• Allowed to hold until the price of securities equal to investment cost

• Dividends received can be used to expedite the disposal

• Allowed to subscribe to/receive any new issue of securities by the company e.g. rights, special, bonus to expedite disposal

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Thank You

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Members of SC’s Shariah Advisory Council

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Y.A.Bhg. Tun Abdul Hamid bin Haji Mohamad Former Chief Justice Malaysia

Y.Bhg. Tan Sri Sheikh Ghazali bin Haji Abdul Rahman

Shariah Legal Advisor, Attorney General’s Chambers

Y.Bhg. Datuk Dr Mohd Daud Bakar Group Chairman, Amanie Advisors

Y.Bhg. Dato’ Dr. Abdul Halim bin Ismail Chairman, Shariah Committee of Shariah-Compliant Funds of Amanah Mutual Bhd

Sahibus Samahah Dr Haji Zulkifly bin Muda Terengganu Mufti

Prof Dr Ashraf bin Md Hashim Chief Executive Officer, ISRA Consultancy Sdn Bhd

Prof Dr Engku Rabiah Adawiah Engku Ali IIUM Institute of Islamic Banking and Finance (IIiBF), International Islamic University Malaysia

Prof Mohamed Ismail bin Mohamed Shariff Adjunct Professor, International Centre for Education in Islamic Finance and Founder of Mohamed Ismail & Co.

Prof Madya Dr. Aznan bin Hasan Ahmad Ibrahim Kulliyyah of Laws, International Islamic University Malaysia

Prof Madya Dr Asmadi Mohamed Naim Dean, Islamic Business School, Universiti Utara Malaysia

Dr Shamsiah Mohamad Senior Researcher, International Shari’ah Research Academy for Islamic Finance (ISRA)

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Quantitative Assessment – Business Activity Benchmarks

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Previous

Benchmark

Revised

Benchmark Activity

5%

5%

Conventional banking; Conventional insurance; Gambling; Liquor

and liquor-related activities; Pork and pork-related activities;

Non-halal food and beverages; Shariah non-compliant

entertainment; and other activities deemed non-compliant

according to Shariah

10%

Interest income from conventional accounts and instruments;

Tobacco and tobacco-related activities; and other activities

deemed non-compliant according to Shariah

20%

20%

Rental received from Shariah non-compliant activities; and other

activities deemed non-compliant according to Shariah

25%

Hotel and resort operations; Share trading; Stockbroking

business; and other activities deemed non-compliant according

to Shariah

• Streamlined business activity benchmarks are as follows:

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Revised Screening Methodology

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• Revised methodology introduced is in line with global practices in Shariah screening of securities.

SC Malaysia Dow Jones Islamic Market Indices

FTSE Shariah Global Index Series

Scope Malaysian Stocks Global Stocks Global Stocks

Screener Regulator Index Provider Index Provider

Discretion Qualitative stage of screening N/A N/A

Denominator Total Assets (TA) Market Cap (MC), Trailing 12-month Average

Total Assets (TA)

Income Contribution Ratios

Specific non-compliant activity income < 5% or 20% of total revenue and profit before tax depending on activity

Specific non-compliant activity income < 5% of total revenue

Total interest and non-compliant activities income < 5% of total revenue

Financial Ratios

• Total debt/TA < 33% • Cash/TA < 33%

• Total debt/MC< 33% • Cash+Interest bearing

securities/MC < 33% • Receivables/MC < 33%

• Total debt/TA< 33% • Cash+Interest bearing

securities/TA < 33% • Receivables/TA < 50%

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Quantitative Assessment – Financial Ratio Benchmarks

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Financial ratios introduced are intended to measure riba and riba-based elements within a company’s balance sheet: • Cash over Total Assets

• Cash will only include cash and cash equivalents placed in conventional accounts and instruments, whereas cash placed in Islamic accounts and instruments will be excluded from the calculation.

• Debt over Total Assets

• Debt will only include interest-bearing debt whereas Islamic debt/financing or sukuk will be excluded from the calculation

Both ratios must be lower than 33%.