Changing the Rules

ZAWYA.COM--Malaysia is known as a leader in Islamic finance; new laws to be rolled out later this year will see it leading the industry in a new direction

When it comes to Islamic finance, Malaysia may seem to have it all but it still wants more. Late last year, Malaysia announced that it is aiming to double the share of Islamic banks in the country from 20 per cent to 40 per cent by 2020. The blueprint which charts how it will get there is contained within the Islamic Financial Services Act 2012 (IFSA), dubbed the world's first comprehensive legal framework for Islamic finance. Recently, Malaysia's leaders have elaborated on what this means for the industry.

"In Malaysia, the new legal framework for Islamic banking and Takaful that will come into force this year, will pave the way for the development of an end-to-end Shari'ah-compliant regulatory framework for the conduct of Islamic financial operations," explained Dr. Zeti Akhtar Aziz, Governor of Bank Negara Malaysia in a speech at the Brunei Darussalam Islamic Investment Summit 2013. "This new framework provides clarity on the fundamental requirements of Shari'ah that must be adhered to for the contractual arrangements between the financial institution and the customer to remain enforceable. The framework also outlines the operational requirements for the effective application of Shari'ah principles in the conduct of Islamic financial institutions. This aims to strengthen the risk management practices beyond the traditional credit, market and liquidity risks, to also include inventory risk, ownership risk and Shari'ah compliance risk. The legislation also provides for the resolution of Islamic financial institutions to be in line with distinctive elements of the relevant Islamic contracts, thus improving the legal and procedural aspects for the orderly resolution of Islamic financial institutions.

"This is to provide greater certainty and to build public confidence in the system as a whole. This necessitates a legal framework that enforces end-to-end Shari'ah compliance in the Islamic financial services industry - through provisions and mechanisms that unambiguously define the conduct and governance of Islamic financial institutions. It needs to recognise the distinct elements in Islamic finance and identify risks and challenges associated with the different Islamic contractual arrangements and the instruments for the appropriate regulatory treatment of the Islamic financial transactions. There is also a need for court recognition and acceptance of the Islamic contracts within the common and civil law systems, with a consistent approach of interpreting the rights of the contracting parties based on Shari'ah principles. This will lend certainty and predictability to the financial transactions and is particularly important in evolving legal frameworks that are facilitative of cross-border transactions as Islamic financial activities continue to venture beyond domestic borders."

The new rules will shakeup the industry in different ways. For example, under the new rules many insurance companies will have to split their life and general insurance and conduct the two as separate businesses. Takaful companies, which are more likely to have a composite licence, are the most likely to feel the effects of this. However, industry players see this as a positive step for the industry.

"The recent introduction of the Islamic Financial Services Act 2013 (IFSA) on 22 March 2013 has marked another step for the Islamic finance industry in Malaysia," Zafri Ab. Halim, Chief Executive Officer of Great Eastern Takaful, told Islamic Business & Finance. "There are mixed responses from the market, however in general it generates a positive step moving forward.

"IFSA reiterates and binds the importance of Shari'ah, proper governance and customer conduct for the Islamic finance industry in Malaysia. This is actually very good for the industry as it shows how the industry has matured and grown. IFSA will also harmonise the regulatory framework covering both the conventional and the Islamic finance industry. Where there are specificities to the Islamic sector, these are covered via an additional provision. Thus, the approach provides clarity and structure 

to regulations.

"However, the challenge is on the Takaful operators' readiness to comply with the new regulatory requirements considering the lack of resources and talents available. Another challenge is changing some conventional processes to be compliant in a short period of time."

Resources to support these ambitious plans were much discussed at Malaysia's 2014 budget consultation meeting, held on 18 June. Finance Ministry Secretary General, Tan Sri Dr Mohd Irwan Siregar Abdullah is quoted by Bernama as saying that robust growth in the global Sukuk market, led by Malaysia in recent years, had made it an important sector for the Government.

"We talked about agro Sukuk to help companies involved in farming activities raise capital to finance their businesses, alongside other forms of Sukuk. We are also looking at other ways to introduce new products in the Sukuk market in the coming years. This is to enable Malaysia to continue being the industry leader," Abdullah told Bernama.

Malaysia's Islamic capital market had contributed significantly to the development of the global Islamic capital market, Bernama quoted Abdullah as saying. At the same time, he reportedly added, non-Muslim countries like Japan and Korea have been attracted to learn from Malaysia on how to introduce Islamic financing to raise their own capital.

In his keynote speech as the 4th Annual World Takaful Conference: Family Takaful Summit, Abdullah explained, "Malaysia's Islamic finance industry has been in existence for over 30 years and that Malaysia's long track record of building a successful domestic Islamic financial industry of over 30 years gives the country a solid foundation that adds to the richness, diversity and maturity of the financial system in Malaysia."

According to Zeti, exporting Malaysia's wisdom will help bind Asia's growing economies. "The trend for greater regional economic and financial integration will also provide substantial opportunities for Islamic financial institutions to facilitate the integration process in the region and with other parts of the world, and thus have a greater role in financing Asia's future growth," she said.

© Islamic Business and Finance 2013