Q&A: Islamic finance regulation and supervision in Malaysia

Supervision

Which are the principal authorities charged with the oversight of banking, capital markets and insurance products?

In Malaysia, the Central Bank of Malaysia (BNM) is the principal authority entrusted to oversee the banking and insurance products by regulating financial institutions under the Financial Services Act (FSA), Islamic Financial Services Act (IFSA) and the Central Bank of Malaysia Act 2009 (CBA), such as, among others, banks, insurers, money brokers and financial advisers. The Minister of Finance (MOF) also plays a role in the regulation of the financial institutions by approving their banking licences and also imposing conditions on the licences. Meanwhile, the Securities Commission (SC) is the statutory body entrusted with the responsibility of regulating the capital markets activities carried out specially by, among others, securities licensees, fund managers and financial planners. This can also involve investment banks licensed under the FSA or IFSA, which also carry out capital market activities in addition to their banking or insurance businesses.

The Labuan Financial Services Authority is the principal authority charged with the oversight of the financial sector in the Labuan International Business and Financial Centre.

Identify any notable guidance, policy statements or regulations issued by the regulators or other authorities specifically relevant to Islamic finance.

Islamic finance relies on sharia principles as its fundamental basis. To ensure compliance, a two-tier sharia governance structure is in place, which comprises of a centralised sharia advisory body, that is the Shariah Advisory Council (SAC) of BNM and the internal sharia committees formed within each individual IFI pursuant to the IFSA. The SAC is the highest authority with respect to Islamic finance in Malaysia. In the event of any conflict between rulings made by the sharia committee of an IFI and the SAC, the SAC rulings will prevail. The SAC plays a vital role in determining the relevant Islamic Law on any financial matter, issuing rulings and guiding BNM and IFIs regarding sharia-related issues pertaining to Islamic financial activities and transactions.

SAC rulings serve as key reference and are binding on IFIs. Courts and arbitrators are also required to consider the SAC rulings in proceedings relating to Islamic financial business. The role of the SAC was clarified in the Federal Court’s judgment of JRI Resources Sdn Bhd v Kuwait Finance House (Malaysia) Bhd issued on 10 April 2019, which emphasised the SAC’s advisory nature and not as a decision-making body that would usurp the role of the courts. The Court of Appeal in Pan Northern Air Services Sdn Bhd v Maybank Islamic Bhd, issued on 11 December 2020 further outlined the process for civil courts to refer sharia issues to the SAC. When there is uncertainty as to when civil courts should refer a sharia issue to the SAC, the civil courts should first determine whether the issue raised is a sharia issue. If confirmed, the court should then check the existing guidelines, rulings or resolutions issued by BNM or the SAC. Where such guidelines are available, there is no need to forward the issue to the SAC. In cases involving multiple guidelines, rulings or resolutions, the civil court should select the most relevant one for the circumstances. Only where there are no applicable guidelines, rulings or resolutions from BNM or the SAC, should the civil courts refer the sharia issue to the SAC.

IFIs must comply with sections of BNM’s policy documents on sharia standards, which involve the determination of Islamic law by the SAC and are intended to implement the advice by the SAC. Failure to uphold these is considered an offence. However, BNM’s policy documents address standards that do not require the ascertainment of Islamic law by the SAC, such as sharia governance, which is not obligatory under the IFSA and serves only as a guidance.

Additionally, IFIs are closely scrutinised by BNM to ensure that stakeholders can evaluate the sharia compliance of the IFI’s Islamic financial activities with confidence. For instance, as per the Financial Reporting for Islamic Banking Institutions issued by BNM on 29 April 2022, IFIs are required to prepare their financial statements in accordance with the Malaysian Financial Reporting Standards. Further, they are also subject to specific minimum disclosure requirements that are designed to provide transparency and allow thorough assessment of the Islamic financial institution’s compliance with sharia principles.

Standards from external sources like the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and Islamic Financial Services Board (IFSB) are not binding on IFIs. Nevertheless, it is important to recognise that the standards from these organisations have enhanced the quality of financial statements and reporting practices of IFIs. Fatwas issued by the National Fatwa Council of Malaysia, though not legally binding, hold significant influence on Islamic practices.

The SC regularly issues and revises guidelines on sharia-compliant securities approved by the SC’s SAC. The SAC employs a two-tier quantitative approach, evaluating the business activity and financial ratios to determine the sharia compliance of listed securities. The list of sharia-compliant securities is updated semi-annually, aiding Muslim investors in making informed investments.

Is there a central authority responsible for ensuring that transactions or products are sharia-compliant? Are IFIs required to set up sharia supervisory boards? May third parties, related parties or fund sponsors provide supervisory board services or must the board be internal?

Yes, the SAC established by BNM ensures the sharia compliance of transactions or financial products in Islamic banking and takaful. The SAC established by the SC under the Capital Markets and Services Act (CMSA) is the principal authority for ensuring that the Islamic capital market businesses or transactions are sharia-compliant.

The IFSA mandates IFIs to establish an internal sharia committee to advise the IFIs in ensuring business is in compliance with sharia principles.

Third parties, related parties or fund sponsors may be engaged to provide supervisory board services, subject to the relevant regulatory approvals. For delegated responsibilities, the sharia committee remains fully accountable for the decisions and any ensuing implications arising from the delegated responsibility.

Do members of an institution’s sharia supervisory board require regulatory approval? Are there any other requirements for supervisory board members?

Yes, members of an institution’s sharia committee supervisory board are regulated under the IFSA. Under the IFSA, no person shall be appointed, reappointed or accept an appointment as a member of a sharia committee unless the person obtains the prior written approval of BNM. That person must also fulfil the ‘fit and proper’ criteria specified in the policy document on Fit and Proper Criteria issued by BNM on a continuous basis and such other conditions as may be imposed by BNM under the governing act or its guidelines. Where the institution is also involved in Islamic capital markets, a licensed Islamic bank and a licensed bank or licensed investment bank approved by BNM to carry on Islamic banking business are deemed to be registered with the SC as a sharia adviser under the Guidelines for Shariah Advisers.

What are the requirements for Islamic banks to be authorised to carry out business in your jurisdiction?

Islamic banks must have a valid licence granted by the MOF on the recommendation of BNM under the IFSA. Also, Islamic banks are required to comply with all the guidelines circulars or directives issued by BNM or the SC wherever relevant, as the case may be, from time to time.

May foreign institutions offer Islamic banking and capital markets services in your jurisdiction? Under what conditions?

Foreign institutions may offer Islamic banking services in Malaysia with a valid licence under the IFSA.

BNM imposes various conditions on institutions licensed under the IFSA such as maintaining minimum capital funds and adhering to a prescribed capital adequacy and financial reporting framework.

For Islamic capital market services regulated under the CMSA both the domestic and foreign IFIs are considered ‘registered persons’ under the CMSA and are, therefore, permitted to carry out certain regulated activities, including dealing in securities, providing corporate finance advice, providing investment advice and fund management. However, the services are limited to those outlined under Schedule 4 to the CMSA.

Foreign institutions can only offer Islamic capital market services in Malaysia if they are licensed under the CMSA, and hold a capital market services licence. Alternatively, they can conduct regulated activities through a related corporation or a non-related corporation in Malaysia that is a capital market services licence holder.

What are the requirements for takaful and retakaful operators to gain admission to do business in your jurisdiction?

Under the IFSA, takaful and retakaful operators must have a valid licence under the IFSA granted by the MOF on the recommendation of BNM to gain admission to do business in Malaysia. In addition, licensed takaful operators must also comply with the relevant BNM guidelines on takaful. For instance, the Takaful Operational Framework guideline issued by BNM provides further guidance related to the specificities of takaful business and also seeks to enhance the practices of takaful fund management.

How can foreign takaful operators become admitted? Can foreign takaful or retakaful operators carry out business in your jurisdiction as non-admitted insurers? Is fronting a possibility?

Foreign takaful operators can only carry on takaful business in Malaysia with a valid licence under the IFSA.

Alternatively, if their business aligns with a licensed business under the IFSA, they may establish a representative office (RO) in Malaysia, to engage in permissible activities, such as research and feasibility studies on investment and business opportunities in Malaysia, with the prior written approval of BNM.

In assessing an RO application, BNM considers factors such as the applicant’s financial position and reputation and its potential contribution in Malaysia. There are no exemptions from the licensing requirements for a foreign institution under the IFSA.

Foreign takaful or retakaful operators are also not permitted to carry on business in Malaysia as non-admitted (unlicensed) insurers. No fronting is allowed in Malaysia.

Are there any specific disclosure or reporting requirements for takaful, sukuk and Islamic funds?

Both BNM and the SC regularly issue guidelines outlining specific disclosure or reporting requirements for takaful, sukuk and Islamic funds.

Takaful operators, as per the Takaful Operational Framework issued by BNM on 26 June 2019 and Risk-Based Capital Framework for Takaful Operators issued by BNM on 17 December 2018, must disclose to BNM information on their policies for managing product risks, including specific information on their IT systems. Specific financial reporting requirements are also imposed on takaful operators under the IFSA and the guideline on Financial Reporting for Takaful Operators issued by BNM on 29 April 2022 to ensure compliance with Malaysian Financial Reporting Standards. Recent developments emphasise digital transformation and cybersecurity in takaful operation; BNM’s Policy Document on Licensing and Regulatory Framework for Digital Insurers and Takaful Operators, issued on 9 July 2024, introduced additional reporting requirements for digital takaful operators, such as cybersecurity risk management and operational resilience.

Sukuk issuers are required to comply with the Guidelines on Islamic Capital Market Products and Services issued by the SC on 28 November 2022 (revised on 8 February 2024), which requires disclosure of various information and documents concerning sukuk prior to submission to the SC. For instance, for the purpose of seeking endorsement of the SAC for ringgit-denominated sukuk, information and documents required to be disclosed include among others, the sharia principles used and the utilisation of the proceeds.

The SC has issued various guidelines concerning fund management, which include the Guidelines on Compliance Function for Fund Management Companies, revised on 19 August 2024, and there are specific reporting requirements that are also applicable to Islamic funds, covering disclosure of information on the assets under management, breaches of securities laws and regulations and steps taken to remedy and prevent such breaches, and the sharia governance framework in place.

What are the sanctions and remedies available when products have been falsely marketed as sharia-compliant?

The IFSA imposes an express obligation on the licensed institution to ensure that its aims, operations, business, affairs and activities are in compliance with sharia laws. Any person who has falsely marketed their financial products as sharia-compliant shall, on conviction, be liable to imprisonment for a term not exceeding eight years or a fine not exceeding 25 million ringgit, or both.

Under the CMSA, this offence is punishable with imprisonment for a term not exceeding 10 years or a fine not exceeding three million ringgit, or both.

Which courts, tribunals or other bodies have jurisdiction to hear Islamic finance disputes?

The civil courts have jurisdiction to hear Islamic finance disputes. Alternatively, the contracting parties can opt to settle their disputes by arbitration. The Asian International Arbitration Centre (previously known as the Kuala Lumpur Regional Centre for Arbitration) provides specific rules relating to Islamic banking and financial services transactions.