Transcript Slide 1
Legal & Regulatory Framework for Islamic Finance Islamic Finance: Structure and Instruments 27 September 2011 Ankara, Turkey. Presented by: Rustam Mohd Idris Deputy Director Islamic Banking and Takaful Department 1 After the session, insyaAllah you would be able to… Gain some insights on Malaysia’s experience in developing legal & regulatory infrastructure of Islamic finance Understand Malaysia’s approach in strengthening existing Islamic finance landscape Appreciate contemporary challenge & understand fundamental building blocks for sustainable Islamic finance 2 Differences of Islamic finance model in various jurisdictions are meant to suit local requirement Bahrain Pakistan Sudan UAE Malaysia Dual Single SYSTEM • Single legislation covers both Islamic & conventional banking LEGAL SHARIAH GOVERNANCE STRUCTURE Single Single • Comprehensive regulatory framework for Islamic banks • Shariah supervisory committee of individual Islamic banks • Single legislation with specific provision to address Islamic banking operation • National aspiration to have full-fledged Islamic • Banking Business Regulation Act Single • Single legislation covers both Islamic & conventional banking (Federal Law) • Takaful –specific law is introduced (2010) • Shariah advisor of individual Islamic banks • Shariah Board of State Bank of Pakistan • Shariah advisor of individual Islamic banks • Shariah committee of individual Islamic banks • Shariah Supervisory • Shariah supervisory Board (Bank of (Ministry of Islamic Sudan) Affairs) • Existence of dual financial system is hard-corded in Central Banking Act 2009 • Dedicated Law/ Act to address Islamic finance • Islamic Banking Act 1983 • Takaful Act 1984 • Government Funding Act 1983 • Shariah advisor of individual Islamic banks • Shariah Advisory Council (SAC) of Bank Negara Malaysia Differences of Islamic finance model in various jurisdictions are meant to suit local requirement (cont…) ACCOUNTING Bahrain Pakistan AAOIFI International Accounting Standard Board (IASB) Sudan UAE Malaysia International Accounting Standard Board (IASB) AAOIFI AAOIFI • Islamic Interbank Money Market (IIMM) CAPITAL & MONEY MARKET Bahrain Financial Exchange (BFX) –the first multi-asset class exchange in the Middle East region n/a n/a Dubai International Financial Exchange (DIFX) offers liquidity for primary listing & secondary trading of Shariah compliant instruments • Labuan International Financial Exchange (LFX) –web based financial exchange that provides listing & trading facilities for Islamic financial product • Bursa Malaysia –Shariah compliant stock exchange • Bursa Suq Al-Sila (BSAS) –commodity trading platform specifically dedicated to facilitate Islamic liquidity management & financing by Islamic banks Malaysia’s approach….develop a comprehensive Islamic financial system …..ensuring sustainability & creating synergy for further development Islamic Money Markets Islamic Banks & Takaful Companies Malaysian Financial System Dual Banking System Islamic Capital Markets Capital Markets Money Markets Supported by: Robust legal & regulatory framework Diversified players with wide-ranging products Integrated human capital infrastructure Professional services with familiarity on IF 5 May 2009 Board Briefing 5 No “one-size-fits-all” approach, but key elements should be considered in developing legal & regulatory framework for Islamic finance… 1 Understand the Fundamental Shariah as the backbone of Islamic finance Specific approach must be taken to ensure adherence to Shariah principles 2 Appreciate the Uniqueness Recognise unique structure of Islamic finance Acknowledge distinctive risks associate with Islamic finance 3 Legal framework (slides 7 – 22) Recognise the Environment Understand local industry Regulatory framework Customise regulatory & supervisory approach to nature of Islamic financial transactions (slides 23 – 33) Full commitment on effort to resolve emerging system-wide issues 4 Acknowledge the Challenge Identify pre-requisites for sustainable system e.g. human capital, infrastructure, capacity & capability Balancing the need for prudential regulation & strategic aspiration 6 Legal Framework 7 Legal Framework Pragmatic development of legal framework to governs specificities of Islamic finance Stage 1: (1983-1993) Instituting foundations Enactment of dedicated acts for Islamic banking, takaful & Shariah compliant government funding Stage 2: (1993 – 2001) Institutional building, activity generation & market vibrancy Legislative amendments to allow Islamic banking windows Stage 3: (2001 – 2010) Strategic positioning & international integration Several measures to ensure legal framework are accommodative of Islamic finance Central Bank of Malaysia Act 2009 Capital Market Services Act 2007 (CMSA) Dispute Resolution Government Funding Act 1983 (GFA) Development Financial Institutions Act 2002 (DFIA) Takaful Act 1984 (TA) Law Review Committee Islamic Banking Act 1983 (IBA) Banking and Financial Institutions Act 1989 (BAFIA) Tax Neutrality Framework Law Harmonisation Committee 8 Legal Framework IBA BNM’s Scope of Powers • Administer carrying on of Islamic banking business by any person • Exercise powers for supervision & control over institutions conducting Islamic banking business Islamic Banking Act (1983) Scope of Business • Accords flexibility to Islamic banks to undertake broad range of Shariah-compliant banking business, subject to specific restrictions Shariah Governance • Provision for the establishment of Shariah advisory body Section 3(5)(b) IBA 1983 • Outlines requirements for ownership, control & management of Islamic banks 9 Legal Framework GFA Scope of Powers on Islamic finance Government Funding Act (1983) Scope of GFA Shariah Governance • GFA provides the power for the Government of Malaysia to issue government bonds based on Islamic principles • The requirement for instruments • GFA administers the power of Ministers to receive investments issued to be in accordance with on behalf of the Government of Shariah principles Malaysia • GFA enables Islamic banks to manage liquidity requirements and surplus funds • GFA outlines the duties and obligations of depository institutions Section 2A of GFA 1983 • Total Islamic + conventional fund raised by government ≤50% of Malaysian GDP Gazette Order dated 9 July 2009 10 Legal Framework TA Scope of Powers on Islamic finance • Administer the carrying on of takaful business by any person • Regulate & supervise institutions carrying on takaful business – Compliance with statutory & prudential requirements – Duty on statistical submission & disclosure – Regulation on governance & change of control Takaful Act (1984) Scope of Business • Family solidarity business (including any type of takaful business carried on as incidental to other solidarity business) Shariah Governance • Requirement to establish Shariah advisory body • General business (all takaful business which is not family solidarity business) 11 Legal Framework BAFIA Banking & Financial Institutions Act (1989) BNM’s Scope of Powers • Administer the carrying on of banking business, financial business, merchant banking business (investment) & money-broking business • Regulate & supervise institutions licensed to carry on those businesses, including carrying on of Islamic banking business & Islamic financial business Scope of Business Shariah Governance • Allow conventional banks to carry out trade activities under Islamic banking business – exemption pursuant to • Allow conventional banking institutions to conduct Islamic banking business (via “Islamic windows”) Section 32 of BAFIA 1989 • Banking & financial Institutions (Trading by Licensed Banks, Finance Companies & Merchant Banks) Order 1994 • Ensures compliance with BNM directives issued in consultation with BNM Shariah Advisory Council Section 124 of BAFIA 1989 12 Legal Framework DAFIA Development Financial Institutions Act (2002) BNM’s Scope of Powers • Administer the carrying on of Islamic banking or financial business by development financial institutions (DFIs) Scope of Business • Administer the carrying on of banking business by DFIs • Regulate & supervise DFIs Shariah Governance • Allow DFIs to conduct Islamic banking business or Islamic financial business • Ensure compliance with BNM directives issued in consultation with Shariah Advisory Council of BNM • Prescribed institutions have recourse to seek advice from BNM Shariah Advisory Council on operations of business Section 129 of DFIA 2002 13 Legal Framework Capital Markets Services Act (2007) CMSA Regulated activity • Regulated activity under CMSA can only be carried on by either Capital Markets Services Licence or registered person Section 58 of CMSA • For the purpose of section 58, registered persons are defined Section 76 of CMSA Scope of CMSA 2007 • Regulate matters relating to activities, markets & intermediaries in capital markets Scope of business • Scope of regulated activity for Islamic banks as ‘registered person – Dealing in securities – Advising on corporate finance – Investment advice – Fund management Schedule 4 of CMSA 14 Legal Framework Malaysia Deposit Insurance Corporation Act (2005) covers various provision on Islamic deposit insurance MDICA 3. Provide insurance coverage when bank fails (3rd party guarantee) 1. Deposit money Depositors Islamic Banks 2. Contribution (premium) based on Tabarru’ Separation & equitable treatment principles Separate management of funds Funded by contribution (premium) collected from Islamic banks Pooled contribution (funds) managed separately Invest in Shariah compliant instruments Equivalent Coverage Limit Islamic deposit covered separately from conventional All coverage limit -similar to conventional Up to RM250k per depositor per member institution Separate Payout Separate payment in event of failure Islamic deposit insurance funds used only for Islamic banks Deficit contribution - can raise funds from government based on Shariah principles 15 Legal Framework SA & RPGTA Tax Neutrality Framework Tax neutrality policy accorded to Islamic banking transactions to level playing field with conventional banking transaction Stamp Act 1949 (Amended in 1989) – Liability of banking instruments to stamp duty – 1989 amendment to avoid double stamp duty for Islamic financing documents (equal treatment for Islamic financial documents in terms of stamp duty) Sec 4 Stamp Act - Instruments chargeable with stamp duty (includes Islamic banking documents) -First Schedule on stamp duty : •Principal document – ad volarem •Subsidiary documents – RM10 - Parties to determine which is principal docs & which is subsidiary docs Sec 14 Stamp Act - For Islamic banking documents “duty chargeable thereon shall be calculated on the principal amount provided by the financier or financing body” - Stamp Duty (Exemption) (No.5) Order 1984 provides guidelines for Murabahah: •PSA = principal doc - Ad valorem stamp duty •PPA = subsidiary doc-RM10 Real Property Gains Tax Act 1979 (Amended in 1985) – Tax payable on gains/profits derived from disposal or acquisition of real property/shares in real property companies – Most of IB transactions involve two sets of exchange that involves acquisition & disposal of assets (eg: selling & buying), theoretically they are subject to two tax – Amendment to sec 3 – avoid double taxation on IBF transactions – Tax is based on the price at the time of disposal and/or acquisition (date of agreement eg: PPA & PSA for murabahah) *PSA = Property Sales Agreement PPA = Property Purchase Agreement 17 Legal Framework Dispute Resolution Multi-tier dispute resolution system Court system Dedicated High Court judge to adjudicate Islamic finance cases • Precedents for Islamic finance cases • Competent pool of judges Arbitration mechanism Kuala Lumpur Regional Centre for Arbitration • Special rules • Speed & confidentiality Mediation Mechanism Financial Mediation Bureau as alternative dispute resolution mechanism … effective legal infrastructure instills public confidence • Scope of jurisdiction • Fast & low cost dispute settlement 18 Legal Framework Law Review Committee LRC To create a conducive legal environment… BNM formed the Law Review Committee in June 2003 Comprising representatives from: – Attorney General’s Chambers; – Ministry of Finance (Tax Division); – Malaysian Bar Council; – Industry players & legal practitioners To review existing laws & make recommendations to relevant authorities Areas of review - taxation and stamp duty laws, company laws, land laws & procedural laws 19 Legal Framework Law Harmonisation Committee LHC Established on 27 July 2010: Chaired by former Chief Justice of Malaysia, which is also SAC member Committee members: – Assistant Governor of BNM – Head of Islamic Capital Market Department, Securities Commission – Attorney General’s Chambers; – Rotating members from industry, legal fraternity & Shariah advisors committee To review existing Malaysian laws in so far as it is applicable to Islamic finance & harmonise them such that they accommodate & facilitate Islamic finance in most legally efficient way possible. To conduct consultation with identified focus groups representing Islamic finance industry, legal practitioners, academicians & relevant Ministries & regulatory agencies 20 Legal Framework Are present laws conducive to support further growth in Islamic finance? Removal of legal impediments & enactment of accommodative laws allow true product innovation to take place Role of legal fraternity • Greater understanding on intricacies of Shariah-compliant transactions facilitate better deliberation on legal disputes HUMAN CAPITAL LEGISLATION Legal fraternity have pivotal contribution in gearing up Islamic finance to the next level Keeping abreast with increasingly sophisticated innovative products • A challenge to product simpler & lesscostly legal documentation without compromising Shariah rules Legal experts to commensurate the exponential growth of Islamic finance • Critical need to expand pool of expertise in emerging new areas of Islamic finance globally Moving forward, robust legal community & infrastructure are critical to support growth in Islamic finance… Shariah Savvy Lawyers • Deep understanding on Shariah matters is pre-requisite to handle litigations in Islamic finance Law Firm Specialising in Muamalat • Specialisation promotes efficiency • Subject matter expert as reference points for market players Robust Legal Documentation Effective Litigation Process • Legal documentation must be in line with Shariah tenets • Lawyers well-versed in cross-border transactions & laws of other countries • Proper cause papers in litigation to ensure conformity with Shariah • Firms with qualified & experienced lawyers for handling litigation 21 Regulatory Framework 22 Regulatory Framework Regulatory frameworks developed based on universal prudential wisdom, with extra consideration on specificities of IF … Preserve sound Islamic financial system Preserve sancity of Shariah conducts Objective: Ensure financial stability Governance of Shariah Committee Governance of Shariah Committee & internal process required to ensure Shariah compliance Capital Adequacy Framework for Islamic Banks (CAFIB) Identification and measurement of risk based on underlying Shariah contracts PSIA as Risk Absorbent Framework Assets funded by PSIA does not require capital if comply with requirements for effective risk transfer Rate of Return Framework Standardise methodology to compute rate of return payable to depositors Guidelines on Profit Equalisation Reserves (PER) Set out operational mechanism & accounting of PER, which is a risk management too to mitigate the effect of displaced commercial risk Property Development & Investment Activities Policy requirements governing Islamic bank’s involvement in property development & property investment activities Guidelines on Musharakah & Mudharabah Contracts Policies & regulatory provisions that govern Islamic banking assets structured based on Musharakah and Mudharabah contracts Financial Disclosure for Islamic Banking Institutions Provide basis for disclosure and presentation of reports & financial statements Firewalls for Islamic window operation Specific guidelines for Islamic window that seek to promote strategic focus in Islamic banking business & ensures no co-mingling of funds 23 Regulatory Framework Credible Shariah governance structure supported by clear Shariah governance framework promotes integrity & confidence in conduct of IF Malaysia’s experience: Shariah as overarching principle in Islamic finance Shariah Advisory Council (SAC) Management Board Shariah Committee Shariah Compliance Functions : Shariah Review Shariah Audit Proper governance provides multi-layer assurance on Shariah compliance 1. SAC’s legislative stature as highest authority for Shariah matters in Islamic finance is accorded under the Central Banking Act. 2. Bank’s Shariah committee are fully accountable on decision, views & opinions on shariah matters 3. Board & senior management with sufficient expertise & capability in dealing with issues specific to Islamic financial transactions 4. Emphasise the function of Shariah review & Shariah audit to provide check & balance 5. Timely disclosure on Shariah resolutions & rulings assure certainty & public confidence Shariah Governance Framework Shariah Parameters Shariah Resolutions & Rulings 6. Institutionalise mutual respect by recognising differences of Shariah interpretations in various jurisdiction 7. Shariah parameters provide guidance on main features, principles & rulings of Shariah contracts 24 Regulatory Framework Capital Adequacy Framework for Islamic Banks Islamic banking institutions subject to the capital adequacy framework based on IFSB Capital Adequacy Standard – Complement Pillar I of Basel II – Risk profiles & exposures determined based on underlying Shariah contracts (asset-based, lease-based & equity based): – Adopt risk measurements, covering credit risk, market risk & operational risk Adoption of advance risk measurement approaches subject to meeting BNM’s requirements Minimum capital adequacy requirements of 8%, consistent with Basel requirement Risk profile Shariah contracts Trading book instruments, Forex, Commodities & Physical assets Risk exposures exposures & & Risk measurement measurement Credit risk; Market risk; and Pillar I of Basel II Operational risk Capital requirement Minimum of 8% 25 Regulatory Framework Profit sharing investment account (PSIA) as risk absorbent framework IBs may deduct credit and market RWA funded by PSIA funds if these risks are effectively & fully transferred to PSIA holders Capital Base RWCR Four Recognition Criteria for Islamic banks 1 = Total RWA Credit and Market RWA funded by PSIA Less Governance of PSIA 2 Adequate legal provisions on effective risks transfer • Emphasised role of Board & senior management in managing PSIA funds • Explicit statement in contract that losses arising from assets funded by PSIA shall be borne by PSIA holders • Ensure legal enforceability of PSIA contract 3 4 Identify and match assets with funding sources • Tagging capability facilitates measurement of risks & return • Appropriate identification & measurement of losses will ensure effective risk transfer to PSIA holders Timely disclosure on relevant information to PSIA holders • Enables PSIA holders to make informed investment decision • Facilitate assessment of risks & return profile of investment portfolio and monitoring of investment performance 26 Regulatory Framework Rate of Return (ROR) Framework Arises from contractual relationship i.e. mudharabah (profit-sharing) Investorentrepreneur Bank invests depositors’ funds in financing, securities etc. Assets managed by bank Depositors have direct financial interest Profit-sharing Based on profit-sharing ratio • Standardise calculation method of rate of return for Islamic banking industry • Ensure depositors receive fair portion of investment profit PER to mitigate/ minimize liquidity risk Amount appropriated out of the total gross income in order to maintain a certain level of return for depositor provision shared by both the depositors and the bank Monthly PER is capped at 15% of total gross income IBs are allowed to maintain max. accumulated PER up to 30% of total shareholders’ funds 27 Regulatory Framework Management of funds under Islamic banking operations Sources of funds Application of funds Non-mudharabah deposits General pool Profit Depositors Bank Unrestricted mudharabah Investment account Restricted mudharabah Investment account ROR Framework Distribution of profit Specific account I Specific account II Depositors or Calculation table Calculate profit Distribute profit Distribution table ..demand for enhanced risk management capabilities and funds management skills.. 28 Regulatory Framework Guidelines on Property Development & Property Investment Activities Property investment Property development − Direct undertaking of property development activities are prohibited. − Involvement restricted to joint venture or equity participation with reputable developer Governance − Direct or indirect acquisition of completed properties or land for onward sale or lease are allowed • Banks’ internal policy to cover, among others: – Allowable exposures based on business strategy, – Assurance to avoid involvement in speculative activities & ensure compliance with Shariah – Internal limits to individual exposure & overall sectoral exposure Risk management • Banks expected to have property research, valuation & marketing capabilities (in-house expertise or outsourced to external parties) Prudential limit • Each exposure ≤ 25% of capital base; and • Total investment in property + unit trust fund + property trust funds + shares & interest in shares ≤ 50% of capital base 29 Regulatory Framework Guidelines on Musharakah & Mudharabah (MnM) Contracts for Islamic Banking Institutions Board & senior mgt expected to have adequate knowledge & understanding on MnM of bank’s representative in board of investee companies subject to prescribed fit & proper criteria No restriction, subject to bank’s due diligence on suitability of funding sources Appointment Governance Funding sources Key Requirements Comprehensive risk management & compliance with capital adequacy requirements that commensurate with risk profile of MnM Risk management Financial disclosure Banks Prudential limit Subject to disclose MnM activities & risks in financial statement to financing & investment limit 30 Regulatory Framework Financial Disclosure for Islamic Banking Institutions Financing Financing by by contracts contracts Disclose various Shariah contracts applicable Income statement Income statement Disclose incomes and expenses that either shared by Bank and depositors or solely belonged to the Bank Profit Profit equalisation equalisation reserve reserve (PER) (PER) Policy on PER & movement of PER provision and write-back Outstanding PER – in other liabilities Deposits from customer Deposits from customer Salient reporting & disclosure requirements Classification based on non mudharabah & mudharabah funds Duties of Shariah committee & Report of the Shariah Committee Disclose on SC’s function & duties Disclose a Statement of the Shariah Committee members on the conformity of Islamic banks operations with Shariah principles Provision/ write back of PER – in income statement 31 Regulatory Framework Firewalls for Islamic Window Operation OUTCOMES… Issuance of specific guidelines on Islamic window operations Promote strategic focus in Islamic banking business Ensures no co-mingling of funds Promote transparency and fairness Proper segregation of funds Allocated capital for Islamic banking operation Established dedicated Islamic banking division Min. CCR (4%), RWCR (8%) Min. Islamic Banking Fund Separate compliance to Statutory reserve requirements, liquidity framework, provisioning & single customer limit POLICY INITIATIVES Islamic funds are segregated from conventional funds Separate clearing accounts Separate membership code in RENTAS* Separate cheque clearing system Separate disclosure of Islamic banking portfolio in financial statements Separate submission of statistical reports in Financial Inst. Statistical System on monthly basis * RENTAS - Real Time Electronic Transfer of Funds and Securities 32 Regulatory Framework Regulatory framework in Malaysia are consistent with internationally accepted global prudential standards that cultivate best practices in IF ISLAMIC FINANCIAL SERVICES BOARD (IFSB) Formulate prudential standards for Islamic financial institutions (IFIs) Guiding Principles on Risk Management (2005) Governance for Islamic Collective Investment Scheme (2009) Capital Adequacy Standard (2005) Capital Adequacy Requirements for Sukuk, Securitization & Real Estate Investment (2009) Guiding Principles on Corporate Governance (2006) Key Elements in Supervisory Review Process (2007) Disclosures to Promote Transparency & Market Discipline (2007) INTERNATIONAL GUIDELINES & BEST PRACTICES Governance for Takaful (2009) Conduct of Business (2009) Shariah Governance System for IFIs (2009) 33 As dynamism of Islamic financial system continues, further improvement on all front is imperative to create strong fundamentals Key Building Blocks Supportive Legal Framework Robust Governance Effective Regulation Supervisory Framework Financial Surveillance Customer Protection Areas for consideration • Enactment of key legislations & amendment to existing statutory law to cater for uniqueness of Islamic financial transactions • Higher standards of corporate & Shariah governance provide multi-layer assurance on compliance with Shariah • Implementation of international prudential standards for Islamic finance issued by IFSB allow regulatory convergence • Responsive supervisory framework necessitates forward-looking paradigm & pro-active dialogues to understand value proposition & inherent risks in Islamic finance • Enhancement of macro/micro surveillance & early warning signals to enable prompt remedial actions • Introduction of Islamic deposit insurance scheme, better disclosure regime & consumer education programmes that reduces information asymmetry In conclusion, robust legal & regulatory framework are instrumental towards ensuring sustainability of IF development 34 Informative websites: http://www.bnm.gov.my - Bank Negara Malaysia http://www.mifc.com - Malaysia International Islamic Financial Centre (MIFC) http://iimm.bnm.gov.my - Islamic Money Market http://bondinfo.bnm.gov.my - Malaysian Government Securities Market http:// www.sc.com.my - Securities Commission Malaysia http://www.pidm.gov.my - Malaysia Deposit Insurance Corporation Disclaimer: While every care is taken in the preparation of this publication, no responsibility can be accepted for any errors. 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