Session 5 Interest Scheme Act in Need of Reformation: By: Prof. Dr. Ashraf bin Md. Hashim* CEO ISRA Consultancy Sdn. Bhd. * Prof. Dr. Ashraf Md. Hashim is the CEO, ISRA Consultancy Sdn. Bhd. He is also a Senior Researcher at International Research Academic for Islamic Finance (ISRA) and a Professor at International Centre of Education for Islamic Finance (INCEIF). He is also a committee member of National Fatwa Council (Majlis Fatwa Kebangsaan), Shariah Advisory Council of Bank Negara Malaysia, Securities Commission of Malaysia and the Chairman of Bursa Malaysia s Shariah Committee. Disclaimer: This presentation is the view of the presenter. 1
Reformation in Interest Scheme Act The Proposal Current Interest Scheme Act - Conventional Proposed New Interest Scheme Act Amendments to allow: - Conventional, and - Shari'ah Compliance
Malaysia as a Leading Islamic Financial Hub Current Position & Achievement
Malaysia Islamic Finance Snapshot 2013 Total Islamic Finance Assets (banking, takaful, other IFIs, sukuk and other Islamic capital Market Malaysia % OF GLOBAL TOTAL GLOBAL LEADER USD423.29b 25.53% Malaysia No. of Islamic financial institutions 76 7.65% Saudi Arabia (99) Islamic banking assets (includes Development Financial Institutions) USD170.28b 14.02% Iran (USD319.01b) Takaful assets USD8.596b 30.88% Saudi Arabia (USD11.05b) Education Institutions 44 9.22% Malaysia Research Papers (2011-2013) 421 30.89% Malaysia No. of Shari ah Scholars 188 22.46% Malaysia Seminar and Conferences 52 22.51% Malaysia Source: ICD-Thomson Reuters Islamic Finance Development Indicator 2014 4
Malaysia has a comprehensive ecosystem and sophisticated Islamic finance market within a dual financial system Governance Governance, Legal & Regulatory Islamic Financial Services Act Government Funding Act Capital Market Services Act Shariah Advisory Council Central Banking Act Shariah Governance Framework Dispute Resolution Judicial system: dedicated high court KL Regional Centre for Arbitration Financial Mediation Bureau Infrastructure Payment, clearing and settlement, custodian Principal Dealers Listing on Bursa with authorise exchange status 1 Diversified & competitive financial institutions Wellsupported IF ecosystem Reputable brand name on IF 2 3 4 Enactment of Islamic Financial Services Act 2013 Addressing complexity of modern finance More interconnected global marketplace New legislation with greater clarity on distinctiveness of IF business Legislated Shariah compliance enhanced regulatory objective Shariah standards and operational standards Robust legal & regulatory framework Appropriate regulatory treatment in accordance with underlying Shariah principles Islamic Money Market Money market Financial Markets Islamic Banks & Takaful Companies Malaysian Financial System Conventional Banks & Insurance Companies Islamic Capital Market Supported by human capital infrastructure Capital market 5 Non listed companies / Enterprises / SME Legal firm Diversified Players Banking 16 Islamic banks 11 Islamic windows 4 International Islamic banks 6 off-shore fullfledged Islamic banks Takaful Rating agencies 12 takaful operators 4 retakaful operators 5 off-shore retakaful companies Fund Management 36 fund management companies Capital Market Professional Service Trust companies Research companies Accounting Financial Intermediaries Financial Advisors Consultancy Service
A leading Islamic finance marketplace with positive industry growth Assets Capital Market Global leader in sukuk market 63% of total outstanding sukuk globally (1Q2014) 20% targeted market share surpassed Total banking asset RM548.7b (incl. DFIs) Market share 24.2% (1Q2014) Deposits Continued expansion in funding sources Total deposit volume: RM440.7b (incl. DFIs) Market share: 26.8% (1Q2014) Takaful Sustained double digit growth Penetration Rate: 14.1% Average annual growth rate: Contribution: -9.4% (market share: 13.7%) Asset: 10.2% (market share: 10.3%) Financing Robust financing activities supporting the economy Total financing: RM370.8b (incl. DFIs) Market share: 27.1% (1Q2014) 6 ISLAMIC BANKING AND TAKAFUL DEPARTMENT
Fatwa/Resolution Issuing Bodies in Muamalat Matters in Malaysia Shari'ah Advisory Council (SAC) Bank Negara Malaysia Scope: Shari'ah matters related to Islamic banking and takaful. Members appointed by the King (Yang Di Pertuan Agong) Resolutions issued are binding MUST be referred to by Courts and arbitrators for any question concerning Shari ah matters Shari'ah Advisory Council (SAC) Securities Commission Malaysia Scope: Shari'ah matters related to capital market Members appointed by the King (Yang Di Pertuan Agong) Resolutions issued are binding MUST be referred to by Courts and arbitrators for any question concerning Shari'ah matters National Fatwa Council Scope: All other matters not related to Islamic banking, takaful and capital market. Members: all State Muftis and 9 members appointed by the Council of Rulers (Majlis Raja-raja) and 1 Legal Adviser The Council s views are respected by the public Not binding unless gazetted by the states.
The Development of Fatwa, Regulations and Legal Acts in Islamic Banking and Takaful in Malaysia
Central Bank Act 2009 Empowerment of Shariah Advisory Council Some Highlights: 53. (1) The Yang di-pertuan Agong may, on the advice of the Minister after consultation with the Bank, appoint from amongst persons who are qualified in the Shari'ah or who have knowledge or experience in the Shari'ah and in banking, finance, law or such other related disciplines as members of the Shari'ah Advisory Council. 56. (1) Where in any proceedings relating to Islamic financial business before any court or arbitrator any question arises concerning a Shari'ah matter, the court or the arbitrator, as the case may be, shall (a) take into consideration any published rulings of the Shari'ah Advisory Council; or (b) refer such question to the Shari'ah Advisory Council for its ruling. 57. Any ruling made by the Shari'ah Advisory Council pursuant to a reference made under this Part shall be binding on the Islamic financial institutions under section 55 and the court or arbitrator making a reference under section 56. 58. Where the ruling given by a Shari'ah body or committee constituted in Malaysia by an Islamic financial institution is different from the ruling given by the Shari'ah Advisory Council, the ruling of the Shari'ah Advisory Council shall prevail.
BNM Shari'ah Standards and Operational Requirements
Example: Mudarabah Operational Requirement Shariah Standard
Shari ah in Islamic Finance : An Overview
وما ارسلناك إال رحمة للعالمين And We have sent you (O Muhammad) not but a mercy to the whole universe (Al-Ambiya:107) Human Wellbeing (maslahah) Fair & Transparent Financial Practices Justice Ethical & Social Responsibility Economic productive wealth circulation Fair distribution 3. Attempt to achieve the Maqasid as-shariah (The Objectives of Shariah) Religion Life Intelect Posterity Wealth Preservation and Promotion 13
In Short: Shari ah as the Basis in Islamic financial system... PRINCIPLES The Core: The prohibition of Riba The avoidance of Gharar The engagement in real economic activities The Ethical Principles Avoidance of forbidden activities Fair & transparent financial dealings Commitment of Islamic values MECHANISMS Observing the principles governing the contracts ( aqd) Forms/structures should be inline with the substances/goals Observing the criteria of efficient, effective, fair, just and transparent GOALS Aims to realize the maqasid al-shari ah in the whole dimensions: Micro goals: related to the Individuals Macro goals: related to the society System goals: related to the system itself 14
SSM Interest Scheme Conventional & Shari ah Compliant 15
Conventional Interest Scheme It is a debt investment in which an investor loans money to an entity (typically SME) which borrows the funds for a defined period of time at a variable or fixed interest rate. Interest scheme is an instrument to raise money and finance a variety of projects and activities. Loan Investors/ Interest Scheme Holders Repayment of Loan + Interest (IOU) 16
Shari ah Compliance Interest Scheme It is an investment instrument in which an investor invests money to an entity (typically SME) in the form of partnership/sale based contract/fee based contract, etc. for a defined period of time at a variable (e.g. profit sharing ratio) or fixed (e.g. asset selling price) profit rate. Sale & purchase, capital in partnership, etc. Investors/ Interest Scheme Holders Profit sharing, fee, rental, sale and purchase 17
Comparing Conventional & Shari ah Compliance Interest Scheme Shari ah Compliance Interest Scheme 1. Holder owns assets (in certain contracts/models) 2. Use a variety of contracts to create financial obligations between SMEs and investors; e.g. Sale, lease, equity partnership, joint-venture etc. Conventional Interest Scheme 1. Holder owns cash flow only 2. Simply use a loan contract to create indebtedness 3. Return linked to profit elements in-built in the sale, lease or partnership 4. Instrument may be equity or debt depending on underlying contract 5. Tradability of the scheme depends on the nature of the underlying asset 6. Investment in Shari`ah-compliant / ethical activities 3. Return linked to interest charged out of the loan contract 4. It is a Debt instrument 5. No restriction on the tradability 6. Proceeds are invested in any business without restrictions 7. Risks: Business, asset, credit, etc. 7. Risk: Credit 18
Why Shari ah Compliant Interest Scheme? Competitive source of funding New asset class Wider investor base (Muslim and non-muslim) Attractive and competitive pricing Inclined towards ethical based financing 19
Oversubscription of Sukuk (as comparison for fund raising activities) Some examples: - 2009 Bahrain Government Sukuk (USD750m) 8 times - 2013 MAHB (MYR500m) 3.4 times - 2013 Cagamas ICP (MYR500m) 3 times - 2014 Dubai Government Sukuk (USD750m) 3 times - 2014 Danainfra (MYR2.4b) 5.38 times Bigger pool of investors
Market Trend Towards Shari ah Compliant/Ethical Businesses KWSP-I KWAP PNB (ASN ASNB) Tabung Haji 21
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Shari ah Standard Issued by Bank Negara Mgmt Co Banks (Financial Intermediaries) Investors (Interest Scheme Holders) Shari ah Compliant Interest Scheme to be Issued by SSM Mgmt Co Investors (Interest Scheme Holders) SSM (Facilitator) 23
Investment Money (Loan) Investment Money (Fees + Business Capital) Investment Money (Fees + Business Capital) Investment Money (Rental Feesl) Investment Money (Business Capital) Conventional Interest Scheme Loan & Interest Agency Agency fees Shari ah Compliant Interest Scheme Ijarah al-askhas fees Ijarah al-a yan Rental fees Partnership - Mudharabah - Musharakah Mgmt Co Mgmt Co Mgmt Co Mgmt Co Mgmt Co Profit and Loss Usage of Usurfruct/Services Profit and Loss Profit and Loss Investment Money (Loan) + Interest Investors (Interest Scheme Holders) Investors (Interest Scheme Holders) Investors (Interest Scheme Holders) Investors (Interest Scheme Holders) Investors (Interest Scheme Holders) Credit Risk - Y Credit Risk - Y Credit Risk - Y Credit Risk - N Credit Risk - Y Business Risk - N Business Risk - Y Business Risk - Y Business Risk - Y Business Risk - Y 24
Wakalah Ijarah al Ashkhas Ijarah al- A yan Mudarabah Musharakah Nature Agency Commission Fees Hiring Service Fees Leasing Rental Fees Partnership Profit Sharing Partnership Profit & Loss Sharing Structure Wakalah Structure Ijarah al- Ashkhas Structure Ijarah al- Ayan Structure Mudarabah Structure Musharakah Structure Adaptation of Structure Ice-cream Business Model / Share Farming Share Farming Club Membership/Ti meshares Adaption of Ijarah al- Ayan Adaptation of Mudarabah Structure Adaptation of Musharakah Structure Income Stream to Management Co Fix + incentive (optional) Fix + incentive (optional) Fix Profit & Loss Sharing Ratio Profit & Loss Sharing Ratio Income Stream/benefit to Interest Scheme Holders Profit & Loss of investment Profit & Loss of investment Right to use Profit & Loss Sharing Ratio Profit & Loss Sharing Ratio
Capital Interest Scheme Holders Interest Scheme Holders No capital involve Interest Scheme Holders Interest Scheme holders and Mgment Company Asset Owners (purchased by utilising invested money) Interest Scheme Holders Interest Scheme Holders Mgment Company Partnership Partnership Day to day Management Mgment Company Mgment Company Mgment Company Mgment Company Mgment company through contract
Wakalah Structure 3 SUBSCRIBER/GROWERS MANAGEMENT COMPANY 1 2 SHARE FARMING GROWER S PLOT The subscribers invest in share farming grower s plot. This investment is solely for farming grower s plot which is under restricted agency (wakalah muqayyadah). Share farming grower s plot is the prescribed parcel of land of which the profit of that parcel of land had been allocated to the grower by the Management Company A management company is appointed as an agent to invest the investors monies and receives agency fees. The investment will be monitored by trustee, shariah advisors and independent consultant. Subscriber/growers receives share of profits of investment value on maturity.
Ijarah al-ashkhas Structure 1. Investors subscribe to the CCM business venture by providing business capital and hiring company A to run the business venture. Company A as hired party runs the business venture and receives ujrah (fee) for the service it delivers. 2. Company A appoints a trustee as wakil (agent) to secure the interest of the investors based on wakalah bi ajr contract. Company A pays specific wakalah fee to the trustee. 3. Company A buys the products from the Investors, which are produced from the business venture.
Ijarah al- Ayan Structure Ijarah al-a yan is a financial contract where the usufructs of an asset or a property are transferred to another person in exchange for a rental fee due on him. In this type of ijarah: the lessor is called mu ajjir, the lessee is called musta jir and the rental fee payable to the lessor is called ujrah.
Mudarabah Structure For the purpose of the Guidelines: Mudharabah Interest Scheme Holders or the subscribers of the Mudharabah Interest Scheme shall assume the role Rabbul maal or capital provider Management Company shall assume the role of Mudharib or entrepreneur.
Musharakah Structure For the purpose of the Guidelines, the type of Musharakah contract referred to is general partnership. In this Guidelines, Musharakah Interest Scheme Holders or the subscribers of the Musharakah Interest Scheme and Management Company shall assume the role of partners to each other. The Management Company is appointed to manage the project/ business.
Adaptation of Mudarabah Structure Parties Involved in the Structure 5 Investments Profits/Returns 3 4 Mudharib/Management Company 1 Prospectus * Supporting Parties (Shari ah Advisors and auditors, independent consultants, Trustee Interest Scheme Holders ** 2 1 Pool of investments of Interest scheme Holders Notes: * The Management shall be overseen by supporting parties ** The Trustee shall be appointed by the Management Company via a signing of Trust Deed. The Trustee shall act in accordance with the terms stipulated in the Trust Deed 1. The Management Company issues the prospectus to attract the public subscription 2. The subscription of the Interest scheme holders will be pooled in an investment pool in the hand of the Management Company 3. The capital generated via subscription shall be invested by the Management Company 4. The Management Company shall invest the capital in accordance with the terms of the contract 5. Profits derived from the investment shall be kept, managed and disbursed by the Trustee according to the Trust Deed signed between the Management Company and the Trustee Company.
Adaption of Ijarah al- Ayan 1. Company A promises to lease the asset from investors. 2. Investors appoint company A to purchase the identified asset on their behalf. 3. Company A purchases the asset from a vendor. 4. Investors pay a sum of money which is equivalent to the purchase price of the asset via trustee. 5. The purchased asset is delivered to company A. 6. Company A undertakes to purchase the asset upon maturity of the scheme. 7. Company A rents the asset from the investors for a specified period of time. The trustee will manage the rental on behalf of the company A. 8. Investors exercise their right to sell the asset to company A upon maturity of the scheme.
Adaptation of Musharakah Structure Trustee 2 Management Company Interest Scheme Holders 3 1) Interest scheme holders/investors places their capital contribution for swiftless restaurant business. The management company is appointed as an employee to run the business. The management company may also contributes sum of money and acts as partner as well as manager. 2) Management Company appoints trustee to monitor business activities. 3) Management company runs the business on behalf of interest scheme holders.
Thank you ashraf@isra.my 35