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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)

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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)

    http://atsc/C12/Communications/Image Library/SC_NEW_LOGO.jpg

  • Background Malaysias Islamic finance agenda

    2

    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

  • 3

    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 Msia 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

    3

  • 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 Generals 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

  • Philosophy in developing Islamic finance regulatory framework

    5

    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 IOSCOs

    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

  • 6

    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 Malaysias 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

  • Practical approach adopted for Islamic finance regulation

    7

    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

  • with Shariah framework viewed as a fundamental

    component within the overall regulatory framework

    8

    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

  • 9

    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

    Malaysias case

  • 10

    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

    Malaysias case (contd)

  • 11

    Shariah stock-screening

    List of Shariah compliant securities by SCs Shariah Advisory Council published twice a year

    Regulatory and tax framework to promote growth of ICM

    Malaysias case (contd)

    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.

  • 12

    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

  • 13

    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

  • Shariah stock screening

    14

    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 SCs IPO fee with a maximum of RM50,000.

  • Shariah stock screening historical background

    15

    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 SCs 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 Bursas Shariah indices, as well as investable securities for Islamic funds, ETFs, structured products etc.

  • Shariah stock screening milestones

    16

    Pre-1993

    Shariah screening pioneered by Bank Islam

    1995 Development of shariah screening criteria to facilitate compliance review

    process undertaken by SCs 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

  • The SAC provides a national level shariah compliance review

    17

    Facilitates efforts to promote centralisation and harmonisation of shariah decisions on

    the status of listed stocks SCs 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

  • Revised stock screening methodology November 2013

    18

    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

  • Revised vs. previous screening methodology

    19

    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

  • Impact of revised screening methodology

    20

    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

  • Guidance on disposal of shariah non-compliant securities

    21

    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

  • 22

    Thank You

  • Members of SCs Shariah Advisory Council

    23

    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 Generals 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 Shariah Research Academy for Islamic Finance (ISRA)

  • Quantitative Assessment Business Activity Benchmarks

    24

    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:

  • Revised Screening Methodology

    25

    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%

  • Quantitative Assessment Financial Ratio Benchmarks

    26

    Financial ratios introduced are intended to measure riba and riba-based elements within a companys 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%.