Investment banking activities and licensing requirements

The Islamic Banking Regulatory Framework (the “Framework”) for the Sultanate of Oman was adopted on 18 December 2012 pursuant to Circular 1B 1 of the CBO. In addition to establishing requirements and parameters for Islamic banks, Section 5 of the Framework addresses investment banking activities. These investment banking requirements and parameters are the subject of this article.

The Framework defines seven categories or “tiers” of investment banking activities. These are:

  1. Corporate finance, which is defined as financial advisory services relating to the public raising of capital on the Muscat Securities Market, financings, and mergers and acquisitions of or by publicly quoted companies, including preparation of prospectuses relating to the foregoing;
  2. Project finance, which is defined as involvement in the preparation of detailed plans, analyses and forecasts for the financing of projects and efforts to raise capital on the basis of those forecasts through limited circulation of prospectuses to unconnected third parties; 
  3. Investment brokerage and investment advisory services, which are defined as involving the offering of brokerage services in or from Oman for the purchase and sale of securities on an agency basis and the offering of investment advisory services to investors for securities quoted on the Muscat Securities Market and/or securities approved by the CBO; 
  4. Discretionary investment management services for securities quoted on the Muscat Securities Market and/or for securities approved by the CBO; 
  5. Lead underwriting, which is defined as contracting with an issuer of equity or debt finance and guaranteeing the partial or total placement of an issue of public or private securities for a fee, and sub-underwriting, which is defined as contracting with an underwriter and guaranteeing the partial placement of a public or private issue of equity or debt finance for a fee; 
  6. Custodial and fiduciary services, which are defined as the acceptance and administration of securities in safekeeping and the exercise of trustee functions for third parties; and  
  7. Such other activities as may be defined as investment banking by the CBO, which seems to include activities so defined in case-by-case approval processes. 

The scope of the definition of “investment banking” and its constituent activities is intended to be broad, at least as a conceptual matter, and it is likely that the definitional scope will be broadly construed. However, on its face, the definitional language of the constituent activities is sometimes restrictive. By way of example: Are financings and mergers and acquisitions by companies whose securities are not publicly quoted within the regulatory ambit? The express language defining corporate finance seems in the negative. Are investment advisory services relating to private sales and purchases of securities on an agency basis exempt from the regulatory licensing requirements if the subject securities are not quoted on the Muscat Securities Market or otherwise approved by the CBO? Again, the relevant definition does not seem to apply to those activities. Are “best efforts” or other non-guaranteed placements outside the definition of underwriting of securities? The answer seems to be in the affirmative. These and other definitional issues are likely to arise in the near future, but remain open for the moment. 

An investment banking license may be restricted to a limited subset of the investment banking activities listed in the foregoing definitions or it may include all such activities. Issuance of the investment banking license requires compliance with licensing requirements applicable to conventional investment banking and certain additional requirements that are applicable only to Shari`a-compliant investment banking. The additional requirements include the appointment of a Shari`a Supervisory Board, appointment of an Internal Shari`a Review (as discussed in our previous article), and demonstration of Shari`a compliance capabilities in all relevant matters. The Framework requires that all investment banking activities be conducted in accordance with the Shari`a, be licensed as an Islamic investment bank by the CBO (unless specifically exempted), and receive appropriate approvals from the relevant Shari`ah Supervisory Board. 

Issuance of an investment banking license, and maintenance of an investment banking license as an ongoing matter, require satisfaction of certain specified conditions. First, the licensed activities cannot be in conflict with the public interest, must be beneficial and necessary to economic growth and development in the Sultanate, and must serve a justifiable service need. Second, an applicant for an investment banking license must demonstrate technical, management and administrative capabilities for the type of activities that will be licensed and must provide reasonable assurance that these activities will be conducted with professional competence and financial prudence. 

It seems clear that the CBO intends to monitor market needs and market conditions and regulate the number, types and nature of the investment banks that will be permitted to exist and operate in the Sultanate of Oman. As yet, there is no guidance as to parameters for and considerations of relevance to these public interest, economic growth and development and service need elements of the regulatory discretion of the CBO. 

Investor protection, capital, financial ratios and prohibited activities

The Framework provides for a range of investor protection measures, including disclosure requirements, indemnity requirements, capital and net worth requirements, and various financial ratio requirements. It mandates that a licensed investment bank has “a” primary responsibility to the investors. 

In terms of investor protection measures, each licensed investment bank is required to: 

  1. act with care, prudence and due diligence in undertaking all investment activities; 
  2. disclose all material and relevant information in good faith, with the objective of ensuring fair dealing and transparency;  
  3. ensure that each investor is advised of the nature and extent of the risks of each proposed investment; 
  4. clearly define contractual relationships between the investment bank and its investors and clearly identify all fees and charges for investment banking services; 
  5. if discretionary authority is given to the licensed investment bank, cause an agreement outlining the terms of that discretionary authority to be entered into by the investment bank and the investor prior to the commencement of any investment activity;  
  6. not enter into any transactions that will create an actual or potential conflict of interest between the investment bank and its related parties, on the one hand, and the investors, on the other hand, unless appropriate disclosures are made and necessary diligence is observed;  
  7. clearly separate, at all times, the assets of investors from the assets of the licensed investment bank; 
  8. maintain an adequate level of fiduciary and professional indemnity (Takaful) as determined by the CBO; 
  9. ensure transparency and not publish any misleading information; and  
  10. adhere to such other instructions as shall be issued by the CBO from time to time. 

Licensed investment banks are admonished to observe greater than normal diligence at all times, including with respect to appropriate governance and management structures, policies and procedures, control and oversight, management of fiduciary duties and conflicts of interest, transparency and disclosure of information on a timely, adequate and appropriate basis, and avoidance of misleading information and fraudulent practices. Licensed investment banks are also directed to create a Shari`a-compliant code of conduct for themselves that is duly cognizant of the interests of all stakeholders.

The Framework is to be lauded for expressly noting that investor protection is “a” primary responsibility of licensed investment banks. No mention is made of any other primary responsibilities. Thus, it is currently unclear just how the CBO will balance investor protection against other responsibilities in the licensing and enforcement contexts. However, the degree of specificity afforded to matters of disclosure, transparency, diligence, risk assessment, fiduciary and professional indemnification, corporate governance and management structures, policies and procedures, and similar matters allows for the surmisal that the CBO will approach investor protection with rigor in both the licensing and enforcement contexts.

The CBO may require licensed investment banks to increase their capital and net worth prior to commencement of investment banking activities. The CBO may also issue appropriate procedures for licensed investment banks relating to financial ratios and other requirements in the following categories:

  1. capital and reserves (net worth) ratios to total or partial liabilities, whether such liabilities are on the balance sheet or off the balance sheet; 
  2. capital and reserves (net worth) ratio to all or a portion of the assets of the investment bank, whether such assets are on the balance sheet or off the balance sheet; 
  3. liquid assets to total liabilities, whether on the balance sheet or off the balance sheet; and 
  4. limitations on the maximum underwriting exposures permitted for licensed investment banks, which underwriting limits shall be related to the bank's net worth and be no greater than 20% of net worth (or such other percentage as the CBO may stipulate from time to time). 

A licensed investment bank is prohibited from entering into obligations which may engage its financial liabilities (such as securities underwriting commitments, indemnification obligations and other commitments) in excess of limits specified by the CBO. The CBO has the authority to issue, from time to time, such regulations, instructions or guidance as it deems necessary for the proper alignment and maintenance of adequate capital without decline or risk exposure. The CBO may also determine adequate procedures to ensure the balance between investment banking activities and the CBO’s monetary and credit policies. In addition, the CBO may issue requirements that are bank-specific or more restrictive than general regulations, as well as instructions for guidance, and the bank must comply with such requirements. Additionally, the investment banking businesses of underwriting and launching Islamic Collective Investment Schemes are subject to CBO approval (and, as noted below, may also be subject to the rules and regulations of the CMA).

To our knowledge, no specific ratios, requirements or parameters have yet been developed or implemented by the CBO. The markets will need guidance as to both the general requirements and the case-by-case adjustment parameters that will be applied by the CBO with respect to different investment banks. Hopefully, those ratios and requirements will be announced in the near future. A licensed investment bank may not purchase securities which it intends to hold for its own account or sell securities it already holds for its own account to an investor without disclosure that is acting as a principal in the transaction. In all such transactions, the investment bank must ensure that the price and other aspects of the transaction correspond to arm's-length, third-party parameters. Further, a licensed investment bank may not engage in activities that are not compliant with the Shari`a, that are not prudent, or that are specifically prohibited by the CBO.

Approvals from the Capital Market Authority 

If required by the CBO, each licensed investment bank must also obtain the approval of the CMA prior to undertaking investment banking activities. Islamic Collective Investment Schemes structured as murabaha or wakala contracts are deemed to be capital markets instruments that are subject, primarily, to the rules and regulations of the CMA.