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Legislative and regulatory framework

Malaysia presently finds itself just over a year into the tenure of a new government, at the helm after former opposition Pakatan Harapan's historic victory in the 14th general election in May 2018, and the country's first change of government following 61 years of rule by the previous Barisan Nasional government. Pakatan Harapan had campaigned on the basis of its plan for fiscal reforms entitled, the 'First 100 Days Fiscal Reforms', which outlined its full commitment to undertake responsible and progressive fiscal reforms to both enhance fiscal equity, transparency and accountability and to accelerate productive investment and economic growth in Malaysia. In the Annual Budget 2019 (announced in November 2018), the new government identified key priorities to support the transition of the Malaysian economy towards 'more balanced, sustainable and inclusive growth' and expressed its ambition to promote Malaysia as a global leader in the bond and sukuk markets by establishing a special committee on Islamic finance together with the extension of tax incentives for sukuk, ijarah and wakalah.

Malaysia has developed a sophisticated Islamic finance sector over the past 30 years, which in turn has generated a vibrant business environment for financial institutions, intermediaries, investors, issuers and service providers alike. In the course of this development, Malaysia successfully established a mature and robust Islamic finance regulatory framework and pioneered the dual banking system, wherein both Islamic and conventional financial systems operate and co-exist within a single regulatory framework.

The financial services industry of Malaysia has always been championed as a key driver of Malaysia's economic development. It is one of the 12 national key economic areas (NKEAs) under Malaysia's Economic Transformation Programme (ETP), the national strategic initiative formulated by the previous government to elevate the country to developed-nation status by 2020, and is the foundation of the Financial Sector Blueprint (FSB), the 10-year master plan implemented by the country's central bank (Bank Negara Malaysia (BNM)), for the management of Malaysia's transition towards becoming a high-value-added, high-income economy. A key recommendation under the FSB is for Malaysia to consolidate its success and position itself as a leading international centre and global hub for Islamic finance. Further, the Malaysian government has also committed under its financial services NKEA for Islamic finance in Malaysia to constitute 40 per cent of total financing in Malaysia by 2020.

In January 2017, the Securities Commission Malaysia (SC) announced the launch of a five-year Islamic Fund and Wealth Management Blueprint (the Blueprint) to drive further development and growth of Malaysia's Islamic capital market. The Blueprint envisages leveraging Malaysia's Islamic capital market ecosystem to establish the country as a leading international centre for Islamic fund and wealth management (see also Section VI.iii). The SC has achieved early success in implementing the Blueprint, as 2017 witnessed the maiden public offering of waqf shares by Larkin Sentral, green sukuk issuances, as well as new players in the fund administration and fund management business in Malaysia.

In July 2017, BNM, in collaboration with certain Islamic banking and finance institutions, embarked on the development of several strategies aimed at strengthening the roles and impact of Islamic banking institutions. These strategies, called value-based intermediation, were to focus on delivering the intended outcomes of shariah through the adoption of practices, conduct and offerings that generate a positive and sustainable impact on the economy, community and environment. The new government lost no time in effecting leadership change at BNM and, in July 2018, the Ministry of Finance announced the appointment of Datuk Nor Shamsiah Mohd Yunus as the central bank's new Governor.

Nevertheless, BNM continued to build on the 2017 Strategy Paper on Value-based Intermediation (VBI) and issued three guidance documents in October 2018, namely the Implementation Guide for VBI, the VBI Financing and Investment Impact Assessment Framework and the VBI Scorecard to facilitate the practical adoption of VBI, as VBI aims to re-orient Islamic finance business models towards realising the objectives of shariah. VBI is also consistent with global finance initiatives in support of achieving the Sustainable Development Goals (SDGs) set by the United Nations (UN). Islamic banks continued to make progress in driving the VBI agenda through enhanced offerings and strong institutional commitments and in September 2018, HSBC Amanah Malaysia Bhd launched the world's first UN SDG sukuk.

While it may still be too soon to comment on measures introduced by the new government, it was reported that in the first quarter of 2019 (Q1 2019), Malaysia's Islamic bond market remained the biggest in emerging East Asia, where sukuk comprised 61 per cent of total local currency bonds outstanding. Malaysia was also among emerging East Asian economies that saw the local currency bond market continue to expand over Q1 2019, despite trade conflicts and moderating global growth.

i Legislative and regulatory regimeIslamic banking

In line with the FSB, the regulatory and supervisory framework in Malaysia in respect of the Islamic banking and finance sector was recently consolidated and updated under the Islamic Financial Services Act 2013 (IFSA), the governing law of Malaysia's Islamic finance sector.

As the primary source of legislation governing the licensing and operation of Islamic and international Islamic banking businesses conducted by financial institutions, the IFSA, together with guidelines and circulars issued by BNM, contains extensive provisions on end-to-end shariah compliance, governance and enforcement, which include the following basic premises:

  1. establishing BNM as the shariah regulator over the financial sector;
  2. providing the legal basis for the rulings of BNM's Shariah Advisory Council (the BNM SAC);
  3. prohibiting financial institutions that conduct Islamic and international Islamic banking businesses from carrying out non-shariah-compliant activities; and
  4. empowering BNM to direct and penalise financial institutions for breaches of the IFSA and offences committed thereunder.

Under the IFSA, BNM was conferred regulatory and supervisory powers and was also empowered to issue guidelines and circulars on shariah requirements to promote financial stability and ensure shariah compliance. Following therefrom, the IFSA provides that the operations, structure and the terms and conditions of Islamic financial products and services provided by financial institutions must be shariah-compliant. Any entity that conducts Islamic banking business or international Islamic banking business must possess the licences granted by the Minister of Finance (the Minister) on the recommendation of BNM. There are various measures taken by the authorities to strengthen consumer protection, including (1) the issuance of the revised BNM's Rules on Prohibited Business Conduct in 2016 to supplement the prohibitions on financial institutions from engaging in conduct deemed to be inherently unfair to consumers under Schedule 7 of the IFSA; (2) the establishment of the Financial Ombudsman Scheme under the Islamic Financial Services (Financial Ombudsman Scheme) Regulations 2015; and (3) the setting up of the Malaysia Deposit Insurance Corporation (MDIC) pursuant to the Malaysia Deposit Insurance Corporation Act 2011 (MDICA), under which the MDIC insures consumers against the loss of their deposits (including Islamic deposits) in financial institutions in Malaysia for up to 250,000 ringgit per depositor per financial institution in the event of loss caused by failure of a financial institution holding such deposits.

Islamic capital markets

The Capital Markets and Services Act 2007 (CMSA) constitutes a single framework regulating the licensing of both conventional and Islamic capital market services, market conduct and offering and issuances of securities, including unlisted Islamic securities or sukuk, with the exception of specific laws, regulations and guidelines that apply exclusively to the operation of the Islamic capital market. This marked a major milestone in the SC's continuous efforts to strengthen the capital market regulatory framework.

In this regard, the CMSA provides, inter alia, as follows:

  1. that Islamic securities are securities for the purposes of securities laws;
  2. that any proposal, scheme, transaction, arrangement, activity, product or matter relating to Islamic securities shall comply with the relevant requirements under securities laws and guidelines issued by the SC; and
  3. that the Minister may, for the purposes of securities laws and, on the recommendation of the SC, inter alia, prescribe any instrument or product or class of instruments or products to be:
    • Islamic securities;
    • Islamic derivatives; or
    • Islamic capital market products.

The following features of the CMSA accord greater protection to investors of securities (including Islamic securities) in Malaysia: (1) the SC's power to take civil and administrative actions; (2) the SC is allowed to recover three times the amount of losses through civil action for a wider range of market misconduct; (3) the standards of trustees for debenture holders are enhanced; and (4) investor protection is extended to clients of financial institutions.

With the CMSA, there are various guidelines and practice notes issued by the SC to regulate the Malaysian capital markets, including Islamic capital markets. In 2015, the SC introduced the Guidelines on Unlisted Capital Market Products Under the Lodge and Launch Framework as part of its initiative to promote process efficiency, shorten time-to-market and provide certainty of product offering.

Takaful (Islamic insurance)

Under the IFSA, any companies that are in the takaful business or international takaful business must hold a valid licence granted by the Minister on the recommendation of BNM. Takaful operators must also comply with the relevant BNM guidelines on takaful and have in place an effective retakaful management strategy that is appropriate to the overall risk profile of the takaful business, and ensure that risks are ceded to takaful or retakaful operators. In addition, takaful operators shall not accept inwards reinsurance from insurance or reinsurance companies except where the risk is shariah-compliant and the arrangement is based on shariah-compliant retakaful contracts. In June 2019, BNM issued the guidelines on Takaful Operational Framework, which will come into force on 1 July 2020, thereafter superseding the current guidelines, which were issued on 26 June 2013. The document provides additional guidance related to the specificities of takaful business and also seeks to strengthen takaful fund management practices to ensure their sustainability, and prudent management. Collectively, these guidelines seek to spur greater innovation in the takaful industry while further safeguarding the position of takaful participants.

Collective investment schemes (funds)

The BNM Guidelines on Investment in Shares, Interest-in-Shares and Collective Investment Schemes for Islamic Banks (the BNM Guidelines) constitute the main guidelines governing for collective investment schemes (CISs) offered by Islamic banks. The BNM Guidelines adopt a more principle-based regulatory approach to enable financial institutions to define the scope of their equity-related investments according to capacity and capability. Other than guidelines issued by BNM, the SC has also issued various guidelines governing CISs.

Generally, under the BNM Guidelines, there are two categories of investments that may be made by financial institutions: (1) investment in shares or interest-in-shares of any corporation; or (2) investment in CISs, which includes unit trusts. In addition, the SC has issued various guidelines on the establishment of a variety of CISs that can be invested in by financial institutions.

Midshore financial centre

Labuan International Business and Financial Centre (Labuan IBFC) is the midshore financial centre in Malaysia and provides a platform for local as well as international financial institutions to offer Islamic financial products or services and Islamic capital market instruments in foreign currencies.

The Labuan Islamic Financial Services and Securities Act 2010 (LIFSSA) is the governing law of the Islamic financial industry in Labuan IBFC. The LIFSSA provides for the registration of business vehicles used by financial institutions and the licensing of financial institutions to conduct regulated business activities. The LIFSSA must be read together with any guidelines or circulars issued by the Labuan Financial Services Authority (Labuan FSA).

The LIFSSA provides for the establishment of the Shariah Supervisory Council (SSC), and for the SSC to (1) ascertain Islamic law for the purposes of any business regulated or supervised by the Labuan FSA and issue rulings; and (2) advise on any shariah issue relating to any business regulated or supervised by the Labuan FSA. The SSC, however, may only make rulings upon reference being made to it by licensed or regulated entities under the LIFSSA or as determined by the Labuan FSA. While the rulings of the SSC shall, upon issuance, be binding upon the Labuan FSA and the entity making the referral, the rulings shall not be binding on any other licensed entity, entity regulated under LIFSSA or shariah-compliant entity unless specified as such by the Labuan FSA.

ii Regulatory and supervisory authoritiesBNM

BNM was established under the Central Bank of Malaysia Act 1958 and continues to operate under the Central Bank of Malaysia Act 2009 (CBA). BNM reports to the Minister and keeps the Minister informed of policies governing the monetary and financial sector.

BNM is empowered to act as the regulator of financial institutions under the IFSA, the Financial Services Act 2013 and the CBA. The CBA confers the necessary powers and instruments on BNM to achieve its mandates effectively and legitimises the duality of both the conventional and Islamic financial systems in Malaysia and in doing so, establishes the legal foundation for development of an Islamic financial system within the overall Malaysian financial system. BNM is also the financial adviser to the Malaysian government and its primary objectives include the prudent conduct of monetary policy, financial system stability and the development of a sound and progressive financial sector. Other functions of BNM include the monitoring and supervision of payment systems, money markets and foreign exchange markets by adopting a risk-based supervisory approach that monitors and reviews the manner in which all financial institutions identify, control and deal with their respective business risks.

Notwithstanding the above, it is the Minister who is the authority for the issuance and revocation or imposition of conditions of licences to carry on the businesses provided for under the IFSA on the recommendations of BNM.

SC

The SC is a regulatory body established under the Securities Commission Malaysia Act 1993 (SCMA), which is mandated to regulate the Malaysian capital market (including the Islamic capital market) and which is directly responsible for the regulation, supervision and monitoring of all persons licensed under the CMSA with the main objective of protecting investors. It is also primarily responsible under the CMSA for encouraging and promoting the development of the securities and derivatives markets in Malaysia and for the monitoring and supervision of public listed companies to ensure compliance with securities laws.

Bursa Malaysia Berhad

Bursa Malaysia Berhad (Bursa) operates a fully integrated exchange under Section 15 of the CMSA. It not only provides a complete range of exchange-related services such as trading, clearing, settlement and depository services but also offers various Islamic market products, namely equities, derivatives, commodities and debt securities across all sectors and industries. To perform the tasks and duties assigned under the CMSA, Bursa has set up subsidiaries to handle some of its principal activities. As at 31 May 2019, 77 per cent of securities listed on Bursa are shariah-compliant. Aside from conducting commercial activities, Bursa is also empowered to regulate and administer:

  1. the FTSE Bursa Malaysia Hijrah Shariah Index;
  2. the FTSE Bursa Malaysia EMAS Shariah Index;
  3. the FTSE Bursa Malaysia Small Cap Shariah Index;
  4. the Sukuk Index;
  5. Bursa Suq Al Sila' (an electronic Islamic commodity trading platform); and
  6. listed shariah-compliant instruments, such as Islamic exchange-traded funds, Islamic real estate trusts and Islamic unit trusts.

However, SC, and not Bursa, is responsible for the screening of companies to determine whether they are shariah-compliant for the purpose of being listed on the stock exchange.

Labuan FSA

The Labuan FSA was established under the Labuan Financial Services Authority Act 1996 and is solely responsible for the regulation, supervision and development of the Labuan IBFC under the LIFSSA. Aside from issuing licences for financial institutions operating within Labuan IBFC, it is also empowered to make recommendations, investigate, collect and divulge information and conduct entry search and seizure, as well as to establish or participate in any body corporate for the purpose of promoting research and training.

Shariah advisory councils and shariah committees

Other than the establishment of shariah advisory councils (SACs) within BNM and the SC, individual financial institutions are also required to establish their own internal shariah committees to ensure the shariah compliance of their respective business operations.

BNM SAC

As mentioned earlier, the BNM SAC was established under the CBA as the authority for the ascertainment of Islamic law for the purposes of Islamic financial business. In any Islamic financial business proceedings, the court or arbitrator must refer to the published rulings of the BNM SAC or refer any question concerning shariah matters to the BNM SAC for its ruling, which shall be binding on the court or arbitrator.

SC SAC

The SC Shariah Advisory Council (SC SAC) was established in 1996 to advise the SC on shariah matters relating to Islamic capital market and is the authority for the ascertainment of the application of shariah principles in respect of Islamic capital markets businesses or transactions.

The SC SAC has the following functions:

  1. to ascertain the application of shariah principles on any matter relating to Islamic capital market business or transactions;
  2. to issue rulings on any matters relating to Islamic capital market business or transactions;
  3. to advise the SC on any shariah issue relating to Islamic capital market business or transactions;
  4. to provide advice to any person on any shariah issue relating to Islamic capital market business or transactions; and
  5. such functions as may be prescribed by the Minister.

In carrying out the above functions, the SC SAC adopts two significant approaches. First, by conducting research or studying the validity of conventional instruments from the shariah point of view, where focus is on the mechanism and use of the instruments to ensure their compliance with shariah principles. Second, by formulating and developing new financial instruments based on shariah principles. These approaches have formed the basis in developing several key shariah rulings on sukuk issuance.

Shariah committees of financial institutions

Every licensed holder under the IFSA must establish an internal shariah committee to ensure that its business, affairs and activities are shariah-compliant. It is an independent body that reports directly to the board of directors. The appointment of the shariah committee members must be done with BNM's prior written approval.

All Islamic financial products or services offered by a licensed holder must be evaluated and approved by its shariah committee. The shariah committee may consult the BNM SAC for their ruling on any shariah matter and the latter's ruling prevails over the former's.

Malaysia International Islamic Financial Centre Initiative

In 2006, the Malaysia International Islamic Financial Centre Initiative (the MIFC Initiative) was launched to position Malaysia as an international Islamic financial hub to, inter alia, facilitate Islamic finance business within the Asian region. Pursuant thereto, the MIFC was established as a network of the country's financial sector regulators, including BNM, the SC, the Labuan FSA, Bursa and government ministries and agencies, together with industry participation from the banking, takaful, capital markets, research and talent development institutions and service providers within Islamic finance. The MIFC network has greatly contributed to the development of Islamic finance in Malaysia by building strong ties among key stakeholders locally and abroad.