islamic finance hub

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Malaysia,Asias Islamicfinance hub

PwC


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2 MALAYSIA, ASIAS ISLAMIC FINANCE HUB | 2008


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MALAYSIA, ASIAS ISLAMIC FINANCE HUB | 2008 3

Since our 2006 thought leadership publication entitled, Malaysia as an IslamicFinance Powerhouse, Malaysia has further established itself as a leadinginternational and regional hub of Islamic finance in the Asian region.

Among Malaysias key Islamic financial initiatives are the issuance of new licencesto foreign interests within the domestic Islamic financial institutions, as well asinternational Islamic banks and Takaful operators. Listing rules have also beenliberalised to promote cross-border listings, and Malaysia is now the worlds largest

Islamic bond market with over two-thirds of global outstanding Sukuk.

Worldwide, Islamic finance continues to make significant strides as awareness ofits advantages spreads. Total Islamic financial assets are expected to reach US$2trillion in 2010 from the current estimated US$900 billion. The number of Islamicfinancial institutions globally has increased to more than 300, spanning more than75 countries in East and West.

Islamic finance is the fastest growing financial segment in the world and

PricewaterhouseCoopers expects this to continue.

We hope this publication will provide fresh insights on Malaysias progress in Islamicfinance and also the outlook for the global Islamic finance industry as a whole.

Dato Johan RaslanExecutive ChairmanPricewaterhouseCoopers MalaysiaAugust 2008

ForewordFrom powerhouseto regional hub


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DISCLAIMER

Malaysia, Asias Islamic Finance Hub is published byPricewaterhouseCoopers (PwC) for distribution to its

business associates. This publication includes information

obtained or derived from a variety of publicly available

sources. PwC has not sought to establish the reliability

of these sources or verified such information. All such

information is provided as is and PwC does not give any

representation or warranty of any kind (whether expressed

or implied) about the suitability, reliability, timeliness,

completeness and accuracy of this publication. This

publication is for general guidance only and should not beconstrued as investment advice or any other professional

advice. Accordingly, it is not intended to form the basis

of any decision and you are advised to seek specific

professional advice on any transaction or matter that may

be affected by this publication and/or before making any

decision or taking any action.

2008 PricewaterhouseCoopers. All rights reserved.

PricewaterhouseCoopers refers to the individual members

of the PricewaterhouseCoopers organisation in Malaysiaeach of which is a separate legal entity or, as the context

requires, other member firms of PricewaterhouseCoopers

International Limited, each of which is a separate and

independent legal entity.

ACKNOWLEDGMENT

We would like to acknowledgeBank Negara Malaysia,

Securities Commission

Malaysia, Malaysia International

Islamic Financial Centre and

other organisations for the use

of information extracted from

their publications and websites.

Featured extensively in this publication are images of the Petronas Twin Towers which was designed

to symbolise strength and grace using geometric principles typified in Islamic architecture.


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Malaysia Leading withworld firsts

2002

Issuance ofglobal sovereignIslamic bond orSukuk - US$600

million (RM2.2billion) MalaysianGlobal Sukuk

Issuance of globalcorporate Islamicbond - US$150million (RM540million) Ijarah byKumpulan Guthrie

Bhd

2004 2005 2006

Issuance of domesticcorporate Islamicbond based on Ijarah- US$44 million

(RM160 million)modelled after theMalaysian GlobalSukuk, issued byIngress CorporationBhd

Issuance of Ringgit-denominatedIslamic bond

- US$139 million(RM500 million) by asupranational body,International FinanceCorporation, theprivate arm of theWorld Bank

Global financingfor a sub-federalentity (state) in Asia- US$350 million(RM1.3 billion)Sarawak CorporateSukuk

Issuance ofMudharabah IslamicBond (profit-sharing)valued at US$22

million (RM80 million)by PG MunicipalAssets Bhd

Issuance of SukukMusharakah Bondworth US$694 million(RM2.5 billion) byMusharakah OneCapital Bhd

Islamic residentialmortgage-backedsecurities byCagamas MBS Bhdunder the profit andloss-sharing principle(Musharakah)

Global Sukukindex DowJones CitigroupSukuk Index was

launchedIslamicexchangeablebonds - KhazanahNasional Bhd toraise US$750million (RM2.7billion)

Islamic REITs - Al-Aqar KPJ REIT,fund size of US$50million (RM180million)waslaunched


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Othermilestones

2002 2005 2006 2007

Foundingmemberand hostcountry of

the IslamicFinancialServicesBoard (IFSB)

Largestsupranationaldeal in the ringgitbond market:

The World Bankissued US$211million (RM760million) Ringgit-denominatedIslamic bondsthat will maturein 2010

Establishment ofthe InternationalCentre forEducation in

Islamic Finance(INCEIF)

Dow Jones &Co Inc and RHBCapital Bhdlaunched theDow Jones-RHBIslamic MalaysiaIndex, a co-

branded Islamicindex

Issuance of the worldslargest corporate Sukukto-date valued at US$4.8billion (RM15.4 billion)

by Binariang GSM SdnBhd to facilitate theprivatisation of a cellularphone operator

The first Asian Islamicexchange tradedfund by i-ValuecapManagement, whichhas exposure to the top

25 listed companies onBursa Malaysia, with anauthorised fund size of10 billion units and aninitial fund size of 840million units

Saudi company, DarAl-Arkan InternationalSukuk Co listed its US$1billion (RM0.3 billion)Sukuk Al-Ijara on theLabuan InternationalFinancial Exchange (LFX)

Tesco Stores (Malaysia)Sdn Bhd raised US$204million (RM700 million)Sukuk Musharakah for its

expansion in Malaysia

2008

Telekom MalaysiaBhd issued thelargest Islamic asset-backed Sukuk Ijarah

via Menara ABS Bhdamounting to US$310million (RM1 billion)

The IslamicDevelopment Bank toissue US$155 million(RM500 million)Sukuk to finance itsinfrastructure projects

Industrial Bank ofKorea and Export-Import Bank of Koreaeach proposed toissue up to US$0.9billion (RM3 billion)conventional and/orIslamic Medium-TermNotes Programme


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MALAYSIA AS AN ISLAMIC FINANCE POWERHOUSE | 2008 7


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8 MALAYSIA AS AN ISLAMIC FINANCE POWERHOUSE | 2008

Contents

10 Malaysia as Asias Islamic finance hub

14Malaysia as an international Islamic finance centre

22Islamic capital market34Islamic banking & Takaful

46Islamic finance products & concepts

54Regulation & tax incentives

64PwC Malaysia Islamic Finance Services

66Islamic finance glossary69Acronyms


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MALAYSIA AS AN ISLAMIC FINANCE POWERHOUSE | 2008 9


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Malaysia as AsiasIslamic finance hub

LocationStrategically located betweenMiddle East and Asia Pacific

Time zone

GMT+8; Kuala Lumpur, same as HongKong and an hour behind Tokyo

Population27.2 million (2008); 38.9 miilion (2050)Young population (1/3 below 14 yearsold)

Ethnic

Malay 50% (who are Muslim); Chinese25%; Indigenous 11%; Indian 7%

Language

Bahasa Malaysia (official); English is widelyused; Other popular ones: Chinese and Indiandialects

LegalEnglish Common Law

EconomicStable and diverse - Worlds largest producer

of rubber, palm oil, pepper and tropicalhardwoods and net exporter of crude oil


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Malaysia is fast emerging as

a global and regional hub formultinational corporations (MNCs)

Regional HQ1for over 1,000 MNCs from 30 nationalities, including:

Technology centreEricsson (education, hardware, services & repair)Motorola (knowledge, IT outsourcing)Shell (IT)IBM (IT)

South East Asia, Middle East, AfricaGlobalGlobalAsia Pacific

Finance centreHSBCStandard CharteredOCBC

21 countriesAsia, Africa, Middle EastAsia Pacific

Logistics centreDHL Asia Pacific

Operational HQs include:

Brambles Corporation, LaFarge Asia, Novartis, Kajima, Asea Brown Boveri, Du Pont, AlcanNikkei Asia, Agfa, Aarhus, etc

1 The Government has introduced various MSC (Multimedia Super Corridor) incentives to attract MNCs to establish their regional and/or global hub in theshared services outsourcing market. These MSC status companies are located in a wide corridor, spanning 15km by 50km, between KLIA airport, CyberJayato KLCC city centre and other cyber centres. MSC status also extended to other cyber cities e.g. Penang.


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Driving factors

Mature Islamic banking & finance industry Facilitative government

14 Islamic banksFour foreign banksForeign equity participation in two domesticbanks

More than 50% of customers are non-MuslimEight Takaful operatorsGrowing Islamic finance market share of financesector (Islamic bond over half of outstanding bond)Main centre for global Sukuk issuance forMalaysian, Asian and Middle Eastern companies

Highly attractive tax incentivesStrong & robust regulatory frameworkBusiness-friendly policies and initiativesTalent development initiatives by the Government

e.g. INCEIF

Investment opportunities Global connectivity

Future economic growth corridors:

North Corridor Economic Region (NCER)Iskandar Development Region (IDR)East Coast Economic Region (ECER)Sabah Development Corridor (SDC)Sarawak Corridor of Renewable Energy (SCORE)

Located at the heart of Asia Pacific

Regional transport hubTwo international airportsOne low cost carrier terminal (LCCT)

Seven international ports

NCERECER

SDC

IDR

SCORE


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Malaysias Financial Sector Master Plan

sets out specific recommendationsto create an efficient, progressive andcomprehensive Islamic financial system

Financial infrastructure development

Increasing the number of Islamicbanks to stimulate competitionIncreasing the number of TakafuloperatorsDeepening the Islamic financialmarket

Institutional capacity enhancementIntroducing a benchmarkingprogramme for Islamic bankinginstitutions to be at par withinternational best practicesEnhancing knowledge andexpertiseBuilding strong managementteams

Granting incentives to structureIslamic private debt securities

Regulatory framework development

Strengthening the regulatoryframework for Islamic bankingImproving the regulatoryframework for Takaful

Establishing an effective regulatorystructureCreating a favourable tax regime


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14 MALAYSIA, ASIAS ISLAMIC FINANCE HUB | 2008MALAYSIA,

ASIAS ISLAMIC FINANCE HUB

Malaysia as aninternational Islamicfinancial centre

Overview of Malaysia as aninternational Islamic financial centreMalaysian International IslamicFinancial Centre


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Overview ofMalaysia as aninternational Islamicfinancial centreMalaysias success in Islamic finance was

not achieved overnight. Its progressive

journey started in 1963 with theestablishment of Tabung Haji, the pilgrims

corporation fund.

Twenty years later in 1983, Malaysias

first Islamic bank, Bank Islam Malaysia

commenced operations followed by the first

Takaful operator, Syarikat Takaful Malaysia

in 1985.

Malaysias Sukuk market started in 1990

with a modest issue size of US$39 million

(RM125 million) by Shell MDS Sdn Bhd.

Two Shariah Advisory Councils (SACs),

under Securities Commission Malaysia (SC)

and Bank Negara Malaysia (BNM), were

subsequently set up to provide regulatory

guidance on the development of the Islamicfinance market, instruments and institutions.

In 2000, BNM and SC set out a 10-year

development Master Plan for Malaysias

financial sector and capital market, which

outlined the strategic directions for the

countrys Islamic finance sector.

In late 2006, the Malaysian InternationalIslamic Financial Centre (MIFC) was set up

in a concerted effort by the Government

and various financial regulatory bodies to

transform Malaysia into a vibrant, innovative

and competitive Islamic financial hub.

Source: International Islamic Finance Market, 2007

Chart 1: The evolution of the global Islamic finance industry

Commercialbanking

Commercialbanking

Projectfinance &syndications

Commercialbanking

Projectfinance &syndications

Equity

Ijarah

Commercialbanking

Project finance& syndications

EquityIjarah

Sukuk (Ijarah,Musharakah,Istisnaa)

Structuredalternativeasset

Commercialbanking

Project finance &syndications

Investmentbanking

Equity/ securities/indices

Sukuks (common& hybird)

Structuredalternative asset

Liquiditymanagementtools

Takaful &reTakaful

1970s 1980s 1990s 2000s 2007

Chart 2: Malaysias relative position in global Islamic finance

Source: Kuwait Finance House, 2006

Over the last decade, the cumulative Government policies,

actions and initiatives have resulted in Malaysia being at theforefront of Islamic finance as well as having one of the largest

Islamic finance markets in the world.

The industry has also experienced double digit growth over the

last five years. Between 2004 and 2007, total outstanding Sukuk

increased on average 33% p.a. to US$62 billion (RM213 billion),

while Islamic banks total assets grew at 18% p.a. to US$46

billion (RM157 billion) over the same period.


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Malaysia as a gateway for

Middle East funds into Asia

Holistic and integrated approach

Malaysias advantage over other

regional financial centres is its

holistic and integrated approach

in developing its Islamic financial

centre. Its Islamic finance industry

development strategy covers multiple

areas such as:

Shariah governance framework

Market efficiency (e.g. pricing)

Product innovation

Human resource development

Incentives (e.g. tax, licensing,

market and product liberalisation)

Facilitative rules and regulations

Integrated infrastructure(coordinated effort by

Government, regulators,

intermediaries and exchanges to

develop Islamic finance sector)

With its experience and expertise in Islamic finance, Malaysia is well-positioned to play a strategic role as a gateway for global funds tofinance Asias development needs. In particular, the petrodollar boomfrom the oil-rich Islamic Middle East countries has led to an estimatedover US$2 trillion in funds4from high net worth individuals as well asState Wealth Funds (SWFs) to finance Asias development needs.

Asia, which houses the fastest growing economies in the world suchas China, India and Vietnam, needs an estimated US$1 trillion forinfrastructure between 2007 and 2012 to fuel its economic growth.

Asset size in 2007

RM billion US$ billion

Islamic banking1 157 46

Takaful 9 3

Sukuk outstanding 213 62

Unit trust (NAV)2 17 5

Total3 396 116

1 Excludes the six development financial institutions offering Islamic banking services which are prescribedunder the Development Financial Institutions Act 2002

2 - NAV - Net asset value3 Excludes market capitalisation of the 853 Shariah-compliant securities4 - The wealth of high net worth individuals in the Middle East is estimated to grow at 8% p.a, to reach US$1.8 trillion by 2010. According to Morgan

Stanley, the regions combined SWFs account for more than half the US$2.5 trillion total assets of global SWFs.

Cumulative actions and initiatives taken to develop the market haveput Malaysia at the forefront of Islamic finance as well as having oneof the largest Islamic finance markets in the world with assets worthUS$116 billion (RM396 billion) in 2007.

Table 1: Size of the Malaysian Islamic finance industry


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Chart 3: Integrated andcoordinated approachtaken to developMalaysias internationalIslamic finance position

Conducive environmentfor Islamic finance

Breadth and depth of

financial market

Malaysia

as a globalIslamic financialcentre

Well-definedShariah governance

framework

Facilitative rulesfor issuance

process

Comprehensiveinfrastructure

Incentives forinvestment activities

Innovativestructures andhuman capitaldevelopment

Competitivepricing

Source: Bank Negara Malaysia


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International player presence

Several key initiatives havebeen taken to position Malaysiaas an Islamic finance gatewaybetween Middle East and AsiaPacific. Among others, BNMhas issued three new Islamic

banking licences to major GulfIslamic financial institutions suchas Saudi-based Al Rajhi Bank,Kuwait-based Kuwait FinanceHouse and Gulf-based AsianFinance Bank5.

Besides participating in the localmarket, the new licences provide

opportunities for the MiddleEastern players to use Malaysiaas a platform to expand theirIslamic finance services to therest of Asia.

For example, in 2008, Kuwait-based Al-Aqeelah Groupand Bahrain-based Unicorn

Investment Bank have beengranted licences to establishInternational Islamic Bank (IIB)subsidiary in Malaysia under theMIFC programme.

Under the MIFC initiatives,international Islamic banksare allowed to conduct a wide

array of Shariah-based bankingbusiness in Malaysia withnon-residents in internationalcurrencies other than the Ringgit.In the case of Al-Aqeelah IIB,it will have US$100 million

capital and will be the Kuwaitigroups platform for setting up newoverseas banks. Another Gulf bank,Al Rajhi Bank, which has a domesticIslamic banking licence, is alsogetting an IIB licence, which will

allow it to ride on the parent groupshuge balance sheet to do large non-Ringgit deals.

Malaysia has also opened its Islamicbanking sector to internationalbanks. In 2007, two locallyincorporated foreign banks, HSBCBank and OCBC Bank were granted

Islamic banking licences by BNMto establish separate and wholly-owned Islamic banking subsidiariesin the country. In addition, HSBCGroup is also making Malaysiaas the regional hub for its Islamicbanking services.

Besides the two banks, Standard

Chartered and ABN Amro areconsidering similar moves. StandardChartered already uses Malaysia asa test bed to launch all its Islamicfinance products before offeringthem to other markets.

The increasing presence of foreignplayers will drive competition,

innovation and add greater depthand breadth to both the domesticand offshore Islamic financialmarket. It will also strengthenMalaysias stature as the regionsIslamic finance hub.

Malaysia leads in innovativeIslamic finance products

Worlds largest issuer of Sukukswith 69% or US$62 billion (RM213billion) of the global outstanding

Sukuks as at end 2007Worlds largest Islamic unit trustindustry with 134 Islamic unit trustfunds and NAV of US$5 billion asat end 2007

853 or 86% of total listedsecurities on Bursa Malaysia areShariah-compliant, with a market

capitalisation of US$213 billion(RM705 billion) or 64% of totalmarket capitalisation as at end2007

Track record for productinnovation, leading with worlds firstproduct launches such as globalsovereign and corporate Sukuk,Mudharabah and Musharakah

Sukuks, exchangeable Sukuk andIslamic REITs

Landmark Islamic Sukuk andsecurities launches include Islamicexchangeable bonds, Islamic REITsand global sovereign and corporateSukuks

MIFC named the Best International

Islamic Finance Centre at theLondon Sukuk Summit Awards ofExcellence in 2008

5Asian Finance Bank is supported by Qatar Islamic Bank, RUSD Investment Bank

Inc of Saudi Arabia and Global Investment House of Kuwait


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Malaysian International Islamic

Financial Centre (MIFC)

Capitalising on Malaysias long andprogressive track record of experienceand expertise in Islamic finance, theGovernment and regulators have setup the MIFC in 2006 with the aim ofpromoting Malaysia as an international

Islamic financial centre.

The MIFC initiative is specificallyundertaken by the collective efforts of thecountrys financial and market regulators- BNM, SC, Labuan Offshore FinancialServices Authority (LOFSA) and BursaMalaysia - to provide an integratedand comprehensive approach to the

development of MIFC.

Among the objectives of MIFC are todevelop Malaysia into a centre for theorigination, distribution and tradingof Islamic capital market instruments,for example, Sukuks and treasuryinstruments, as well as Islamic fundand wealth management. Products andservices under the MIFC can be in anycurrency and can be offered to bothresidents and non-residents.

In efforts to promote MIFC, BNM hasintroduced several new offshore Islamicbanking and Takaful licences:

IIB licence to conduct international bankingbusinesses in international currencies

International Takaful Operator (ITO) licenceto conduct international Takaful businessesin international currencies

Existing Islamic banks and Takaful operatorscan set up International Currency BusinessUnits (ICBUs) to conduct the full range ofIslamic banking or Takaful services withnon-residents and residents in internationalcurrencies

Flexibility for Labuan offshore Islamic banks,Islamic divisions of the offshore banks aswell as offshore Takaful operators to openoffices anywhere in Malaysia

Aside from the issuance of the above licences,SC has introduced Islamic fund managementlicence to conduct Islamic fund managementservices in Malaysia. The Government has

announced a wide range of incentives in effortsto create the necessary critical mass of playersand increase the scale of Islamic financeactivities.


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In addition to the many incentives, the Government has further liberalised the foreign exchange administrationrules to allow multilateral financial institutions, multinationals and other national corporations to issue both Ringgitand non-Ringgit denominated instruments from Malaysias capital market. The effort will help deepen and widenthe Sukuk markets, provide linkages with international issuers and investors, and reinforce the internationaldimension of Malaysia as an international Islamic financial centre.

MIFC incentives

10-year tax exemption for IIB andITO up to 2016Tax exemption up to 2016 on themanagement fees received by fundmanagers for managing Islamicfunds10-year tax exemption for existingIslamic banks and Takaful operatorsto set up ICBUsTax deductibility on certain expensesincurred to establish Islamic brokingcompaniesTax exemption on profits paid bylicensed Islamic banks in Malaysiato non-resident customersWithholding tax exemptions onprofits received from Sukuks issuedin MalaysiaTax deduction up to year ofassessment (YA) 2010 for issuancecosts of Sukuks approved by SC10-year stamp duty exemption oninstruments executed by ICBU, IIBand ITO under MIFC20% stamp duty remissionon certain principal or primaryinstrument of financing madeaccording to the principles ofShariah and approved by BNM orSCRemoval of restrictions onownership and investment abroadfor Islamic fund companiesThe Employee Provident Fund (EPF)has undertaken to provide US$2billion (RM7 billion) in investment

mandates to Islamic fund managers

Chart 4: Malaysias Islamic finance industry is globally integrated

MALAYSIA,


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Islamic capitalmarket

MALAYSIA,ASIAS ISLAMIC FINANCE HUB

Islamic debt securities (Sukuk)Shariah-compliant equities and indices

Shariah-based unit trust funds


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Strong and steady

growth in MalaysiasIslamic capital market,from Sukuks toIslamic equities, hastransformed Malaysiainto Asias Islamicfinance hub

Malaysia accounts

for over two-thirds ofglobal outstandingSukuks

Global awareness and interest

The Islamic capital market refersto capital market activities thatare carried out in ways which donot conflict with Islamic principlesi.e. free from prohibited activitiesand elements such as riba (usury),maisir (gambling) and gharar(ambiguity).

In the last decade, there has beenstrong global awareness andinterest in Islamic finance, notonly among Muslims but a widerange of investors who perceiveIslamic financing as a fairer way ofdoing business.

The Malaysian scene

Over the last decade, Malaysiahas developed to be not justAsias Islamic finance hub but alsobecoming a leading internationalhub for Islamic finance. The keydriving factors include:

Central Asian location at theepicentre of a populous Islamic

community, between ASEAN1

and the Middle EastWell-established Islamicbanking systemClose ties to the global Islamicfinancial communityComprehensive regulatoryframework that providescertainty to investors; and

Track record of productinnovation

These factors have enabledMalaysia to successfully attractglobal investors and issuers as apreferred investment destination.

The Malaysian capital marketlargely comprises Islamic bonds(Sukuk), Shariah-compliant equitieswith accompanying Shariahbenchmark indices and unit trusts.

In 2007, Malaysia had the largestSukuk outstanding in the world,accounting for over two-thirds or

69% of global Sukuks outstanding.

The number of Malaysian Sukukissuances approved by the SCwere also almost three timesthe value in 2006 and they werepredominantly based on theprinciple of Musharakah.

Today, Malaysia has achievedinternational recognition as a centrefor the origination, distributionand trading of Islamic private debtsecurities, offering a wide range ofworld-class products.

This strong growth also hasextended to the Islamic unit trust

industry which has experiencedexponential 48% average growthp.a. in NAV in the last five years.

In the Malaysian stock market, 86%of all listed equities are Shariah-compliant with a combined marketcapitalisation of US$213 billion(RM705 billion) as at end 2007.

The growing popularity of Shariah-compliant equities has led to theintroduction of two new indices byBursa Malaysia in collaboration withthe FTSE Group.

1 ASEAN - Association of South East Asian Nations

24 MALAYSIA ASIAS ISLAMIC FINANCE HUB | 2008


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Islamic debt

securities (Sukuk)

Sukuk is the fastestemerging form ofIslamic finance, withMalaysia leading ininnovation

Exponential global growth inSukuks

The Sukuk market is the fastestemerging form of Islamic finance,experiencing rapid growth in thepast few years especially in theMiddle East and Asia, spurred byhigh levels of surplus savings andreserves. The Sukuk market morethan doubled in 2007, continuing itsexplosive growth at an average rateof 40% since 2000.

The size of the global market ofSukuks denominated in domesticcurrencies has risen sharply from

just US$336 million (RM1.3 billion)in 2000 to an estimated US$82billion (RM281 billion) in 2007. TheSukuk market has expanded widelyacross the globe, attracting issuersfrom a larger number of countries.In 2007, more than 100 Sukukswere issued from 10 countries.This trend is set to continue and

other non-Muslim countries likeUnited Kingdom, Hong Kong,Singapore and Japan are expectedto participate in future.

Malaysia Sukuk growth

Over the last five years, theMalaysian Sukuk market registered

an average growth rate of 33%.

In 2007, the SC approved a totalof 120 bond issues, of which 59issues were Sukuk valued at US$35billion (RM121 billion). The valuerepresented 76% of total newbond issues approved, the largest

ever portion of Sukuks approvedin a year. Over the period 2003to 2007, the CAGR (compoundannual growth rate) of approvedSukuk issuances was at anunprecedented growth rate of78%.

Malaysia leads in innovativeSukuks

Malaysia also leads in thedevelopment of the Sukuk market,introducing innovative andcompetitive Sukuk structures thatappeal to a wider investor base.

An example of Malaysiaspioneering efforts in facilitatinginnovative structures include theUS$750 million (RM2.7 billion)exchangeable Sukuk Musharakahby Khazanah Nasional Bhd,the state investment arm of theMalaysian Government. Thisis the worlds first Sukuk that

incorporates full convertibilityfeatures that were previouslycommon only to conventionalequity-linked transactions.

2007 was a landmark year forMalaysia-originated Sukuk withthe issuance of the worlds largestcorporate Sukuk to-date valuedat US$4.8 billion (RM15.4 billion)by Binariang GSM Sdn Bhd. ThisSukuk was twice oversubscribeddespite its significant size.

MALAYSIA ASIAS ISLAMIC FINANCE HUB | 2008 25


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Table 2: Notable Sukuk programmesand issuances in 2007

+ A combination of a few Islamic principles and

conventional bonds++ Issued out of Labuan amounting to US$850 million* Programmes

Source: Securities Commission Malaysia, 2007

Chart 5: Outstanding Sukuks vs. bonds

Source: Bank Negara Malaysia, 2007

Bond Sukuk

2001 2002 2003 2004 2005 2006 2007



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26 MALAYSIA, ASIA S ISLAMIC FINANCE HUB | 2008

Musharakah Sukuksaccount for over halfof Malaysian Sukuks

Sukuk structures

The common Sukuk structures used infinancing include Ijarah, Murabahah,Istisnaa, Mudharabah, Musharakah andBai Bithaman-Ajil.

In Malaysia, the bulk of Sukuks issued

is in the form of Musharakah (profit-sharing), accounting for 58% of totalSukuks approved in 2007, followed byMurabahah (cost-plus profit margin) with19% and Ijarah (lease-based agreement)with 11%.

Key growth drivers for Sukuks inMalaysia

Growing sophisticationof structuresSukuks have evolved fromMurabahah to Ijarah, Musharakah,Istisnaa (pre-delivery and leasing)

and hybrid structures to meet therequirements and preferences ofdifferent target markets.

Clarity of regulatory treatmentThe adoption of Capital AdequacyStandard issued by the IslamicFinancial Services Board (IFSB),which specifies the prudential

treatment of Sukuk transactionsfor regulatory capital purposeshas provided regulatory certaintyto Islamic financial institutionswith regard to their investments.

Strategic focus to developcomprehensive Islamic financialsystemSukuks play a vital role in

supporting the increasingnumber of structured productsoffered by Islamic banks, Takafuloperators and fund managementcompanies.

Chart 6: Size of Sukuks approved in 2007

9%

11%

19%

2%

1%

58% Musharakah

Bai Bithaman-Ajil

Murabahah

Ijarah

Istisnaa

Mudharabah




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Table 3: Innovative Sukuk structures

Year Sukuk structures US$ million RM million

1990First Bai Bithaman-Ajil Islamic debt securities by ShellMDS Sdn Bhd

46 125

1994 First Sukuk Mudharabah by Cagamas Bhd 11 30

2001 First corporate Sukuk Ijarah by Kumpulan Guthrie Bhd 150 570

2002First sovereign Sukuk Ijarah by the Government ofMalaysia

600 2,280

2003 First tradable Sukuk Istisna by SKS Power Sdn Bhd 1,500 5,600

2005 First Sukuk Musharakah by Musharakah One Capital Bhd 660 2,500

2006 First exchangeable Sukuk by Khazanah Nasional Bhd 750 2,800

2007 Largest corporate Sukuk by Binariang GSM Sdn Bhd 4,800 15,400

2008Largest Sukuk Ijarah by Telekom Malaysia Bhd via MenaraABS Sdn Bhd

310 1,000




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Shariah-compliantequities and indices

Shariah-compliantequities accounted forthe majority or 86%of all listed stocks in2007

Shariah-compliant equities

In 2007, there were a total of 853 Shariah-compliant equities, accounting for 86% oftotal stocks listed on Bursa Malaysia.

The market capitalisation of Shariah-compliant equities were valued at US$213

billion (RM705 billion) at the end of 2007,rising sharply by 29% from the previousyear. They represented 64% of the totallisted securities by market capitalisation.

Bursa Malaysias Main Board has thehighest listings of Shariah-compliantequities at 59% followed by the SecondBoard with 27% market share and

MESDAQ2

with 14%.The Shariah-compliant equities have abroad coverage across many sectorsexcept finance. The prominent marketsectors with Shariah-compliant equitiesinclude industrial products with 33% marketshare and trading services at 20%.

2 MESDAQ - Malaysian Exchange of Securities Dealing & Automated Quotation



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Chart 7: Total listed securities by volume Chart 8: Total listed securities by market capitalisation value

Chart 10: Shariah-compliant equities by market sector

Chart 9: Shariah-compliant equities by board listing




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Bursa Malaysia andFTSE Group launched twonew Shariah-compliantindices in 2007

Islamic equity indices

The availability of Shariah-compliantequities led to the development of theIslamic equity index in 1999 known asthe Kuala Lumpur Shariah Index.

This Index was introduced to meet the

growing demand of local and foreigninvestors seeking to invest in securitiesconsistent with Shariah principles.

In 2007, Bursa Malaysia introducedtwo new indices for Shariah-compliantequities in collaboration with the FTSEGroup, the global index provider. Thefirst index is the FTSE Bursa Malaysia

EMAS Shariah Index and the secondis the FTSE Bursa Malaysia HijrahIndex. The two indices are subject tointernational indexing features, namelyfree float adjustment, liquidity andShariah screening.

The launch of these new indices willhelp Bursa Malaysia position itselfas a destination for global Islamic

investment dollars and in enhancingMalaysias position as Asias leadingIslamic finance hub.



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Shariah-basedunit trust funds

The Malaysian Islamicunit trust industry,albeit small, is still thelargest in the world

The Malaysian Islamicunit trust industry

The size of the Malaysian Islamicunit trust industry is smallcompared to the overall domesticunit trust industry as reflected bythe relatively low number of Islamicfunds and its corresponding NAV.Nonetheless, it is the worlds largestIslamic unit trust industry.

As at end 2007, the number ofShariah-compliant funds were 134with an NAV of US$5 billion (RM17billion) or 10% of the total NAV ofthe industry. Despite their small

numbers and NAV, Islamic unittrusts have experienced significantgrowth over the last five years withCAGR in NAV of 41% while thetotal industry funds value recordeda CAGR of 28%. Underpinning theindustrys strong growth prospectsis the rising affluence of Musliminvestors and the expansion of

the range of Islamic capital marketproducts. Also, the MalaysianGovernment in its efforts to promotethe growth of the Islamic fundmanagement industry has offered

several incentives to attract globalplayers to establish Islamic fundmanagement operations in Malaysia.

Besides tax incentives andliberalisation of investment policies,Malaysias EPF will outsource US$2billion (RM7 billion) of its managementfunds to Islamic fund management

companies.Of the Shariah-based unit trust fundsin Malaysia, 61% or US$3 billion(RM10 billion) in NAV were equityfunds, 11% (US$0.5 billion/RM1.8billion) were balanced funds and 10%(US$0.49 billion/RM1.7 billion) wereSukuk funds.



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Chart 11: Number of Islamic funds vs total industry

Chart 12: NAV of Shariah-based unittrust funds by category

Chart 13: Size of Islamic funds vs total industry


Note: *Including feeder funds, fixed income funds, moneymarket funds, structured product and mixed asset funds

Growth*

41%

28%

Islamicfunds

Total funds

*NAV growth p.a. 2003-2007




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Islamic banking& Takaful

Islamic banking & financeTakaful industry



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Islamic banking

& finance

The Islamic financeindustry has rapidlyexpanded beyondMuslim countries andeven powered its way

into mainstream finance

Malaysias Islamicsystem operates inparallel to conventional

Rapid global expansion

The Islamic finance industry hasexpanded beyond Muslim countries inthe Middle East and South East Asiato enter international financial marketslike London, Tokyo and Hong Kong.

In view of the rapid and significantmarket expansion of Islamic finance,the total assets are projected to reachUS$2 trillion in 2010, with growth ofaround 15% to 20% p.a.

Malaysias competitive dual bankingsystem

Since its introduction in 1983, theIslamic financial system in Malaysiahas progressed markedly despitean increasingly liberalised andcompetitive environment.

Malaysias Islamic financial system,based on the concept of profit-sharingas opposed to the use of interest in

the conventional financial system, hasevolved as a competitive componentof the overall financial system. Itcomplements and competes with theconventional financial system and isrecognised as a driver of economicgrowth and development.

Through economic policies and

regulations, Malaysia continues tofoster the expansion of the dualbanking system with both the Islamicand conventional systems operatingin parallel to deliver innovative andcompetitive financial products andservices.

In 2007

In the early phase of itsdevelopment, Islamic financewas essentially domestic-centric,focusing on retail financing, tradefinancing and the financing of othercommercial business activities.However, the drive to diversify thedomestic financial infrastructureto avoid over dependence on

the banking sector and the pushtowards greater liberalisation of thefinancial system has encouragedthe rapid development of Islamicfinance. These two policy drivershave spurred the developmentof the domestic Islamic financialmarket and rapidly integrated it intothe international financial system.

Today, foreign participationin Malaysias conventionaland more recently, its Islamicfinancial system, has furtherinternationalised Malaysiasfinancial system.

300 IFIsoperating incountries,managing

75US$900

billionassets(estimates)


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Liberalisation of MalaysiasIslamic banking market

The liberalisation of Malaysias Islamic bankingmarket commenced with the opening of the firstforeign Islamic bank in August 20051.

The conversion of all Islamic banking windows ofdomestic banking groups into Islamic subsidiariesin 2007 reflects the increasing domestic focus onIslamic banking business, supported by cleareraccountabilities achieved under separate Board andmanagement structures.

Malaysias Islamic banking system is serviced by 13full-fledged Islamic banks and seven participatingcommercial banks in the Islamic Banking Scheme

(commercial banks with dedicated Islamic bankingwindows). Other financial institutions that offerIslamic banking services include six investmentbanks and one international Islamic bank. Three ofthe full-fledged Islamic banks are foreign-owned.They are the Kuwait Finance House (Malaysia) Bhd,Al Rajhi Banking & Investment Corporation (Malaysia)Bank Bhd and Asian Finance Bank Bhd. There arealso six development financial institutions offering

Islamic banking services.In May 2008, two additional full-fledged Islamic banklicences have been approved i.e. Maybank IslamicBhd and Alliance Islamic Malaysia Bank Bhd.

1 Foreign and local Islamic banks are licensed under the Islamic Banking Act 1983



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Malaysias bankingassets doubled insize over the lastfive years

Islamic banking size and growth

Malaysias Islamic bankingindustry has shown significantgrowth, with banking assetsdoubling from US$22 billion

(RM82 billion) in 2003 to US$46billion (RM157 billion) in 2007,growing at 18% p.a. Totalfinancing of Islamic bankinginstitutions grew at 17% p.a.to US$26 billion (RM90 billion)while total deposits grew at 19%p.a. to US$35 billion (RM122billion) in 2007. There is ampleliquidity and financing capacityin Malaysian Islamic bankinginstitutions, with a financing todeposits ratio of 1:2.8.

Chart 15: Total assets, financing and deposits ofMalaysian Islamic banking institutions


2XAssets

US$ bil200322

Financing

US$ bil200313Deposits

US$ bil200316

US$ bil200746US$ bil200726US$ bil200735



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Bai Bithaman-Ajil and IjarahThumma Al-Baiare the mostpopular financing

concepts inMalaysia

Significant household financingactivities

Supported by strong consumerspending, the household sectorcontinued to account for thelargest component (61%) of

financing extended by Islamicbanking institutions in 2007.Household sector loans arelargely for the purchase ofpassenger cars (32%) andresidential properties (20%). Thissignificant household demandwas the result of attractive andcompetitive financing packages

offered by Islamic bankinginstitutions.

Islamic banking is also widelyused for working capitalpurposes, making up 24% oftotal financing in 2007.

In terms of financing concepts,

financing based on the BaiBithaman-Ajil concept remaineddominant, constituting over athird or 37% of total financing.

The Ijarah Thumma Al-Baiand Murabahah concept isgaining more share at 30% and11% respectively in 2007 as

compared to 29% and 7% in2006.

Chart 16: Major financing concepts in 2007

Chart 17: Major financing purposes in 2007




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Islamic interbank moneymarket transaction is twicethe size of Islamic bankingtotal assets

The Islamic Interbank Money Market (IIMM)

The Islamic money market is integral to thefunctioning of the Islamic banking system.Firstly, in providing Islamic financial institutionswith the facility for funding and adjustingportfolios over the short-term, and secondly,

serving as a channel for the transmission ofmonetary policy. Financial instruments andinterbank investment would allow surplusbanks to channel funds to deficit banks,thereby maintaining the funding and liquiditymechanisms necessary to promote stability inthe system.

The Islamic Interbank Money Market (IIMM)

was introduced in January 1994 as a short-term intermediary to provide a ready sourceof short-term investment outlets based onthe Shariah principle. Through the IIMM, theIslamic banks and banks participating in theIslamic Banking Scheme would be able tomatch the funding requirements effectively andefficiently. BNM issued the Guidelines on theIIMM in December 1993 to facilitate proper

implementation of the IIMM.

The Islamic interbank market has been veryactive with US$112 billion (RM385 billion)worth of transactions in 2007 which is twice thesize of the total assets of the Islamic bankingindustry in 2007.

Transactions in the interbank money market

mainly revolves around Mudharabah-based instruments. BNM is also promotingcommodity Murabahah to the market aspart of its continuing efforts to promoteproduct innovation and facilitate the liquiditymanagement of Islamic financial institutions.



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Takaful industry

The Takafulpenetration rate inMalaysia is expectedto reach 20% by2010 from 6.5%currently

Emerging global growth area

The global Islamic insurance(Takaful) is an emerging growtharea with significant growthmomentum and increasingparticipation of Takaful players in

the global market.

Total global Takaful premiums areexpected to grow by some 15%to 20% p.a. to reach US$7 billionin 2015 from about US$2 billionto US$3 billion currently. To date,global Takaful assets is estimatedto be around US$20 billion.

The strong growth is attributedto the increasing number ofcompanies offering Takafulservices across jurisdictions.Currently, there are more than250 Takaful operators worldwide,operating in over 20 countries.An important development is thatthere is growing participation of

established conventional players inthe Takaful and reTakaful industry.Large conventional players fromthe United Kingdom, United Statesand Germany have set up Takafulor reTakaful companies within theirgroups.

Following the phenomenalgrowth of various componentsin the Islamic financial system,particularly the Islamic bankingsector and the Islamic capital

market, there is now an emergingglobal demand for Takafulproducts.

The advancement by bothsectors contributed towards thestrong growth of the Takaful andreTakaful industry. For instance,the tremendous growth of Islamic

financing and mortgages providecomplementary demand formortgage protection with Takafulcovered as part of mortgageprotection packages.

Meanwhile, the increasingpopularity of Sukuk issuance withlonger tenure to match investmentand risk management of longer-

term liability is spurring the growthof investment-linked Takafulproducts.



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Malaysian Takaful marketdoubled in asset size overlast five years

Growing Malaysian market

The Malaysian Takaful market hasachieved commendable growthsince its inception in 1984 whenthe first Takaful operator, SyarikatTakaful Malaysia was establishedunder the Takaful Act 1982 tofulfill the needs of the generalpublic to be protected based onIslamic principles.

Malaysian Takaful fund assetsis now about US$3 billion (RM9billion) in 2007, representing7% of the total assets of theinsurance and Takaful industry inMalaysia.

The number of registered Takafuloperators grew from two to eightcomposite Takaful operators,with about US$0.8 billion (RM3billion) contribution in 2007.Based on the current globalTakaful contributions estimatedat US$4 billion, Malaysia is the

largest player with over 20% ofthe market.

The Malaysian Takaful marketalso presents huge growthopportunities, given the existingMuslim population of about15 million and the low Takafulmarket penetration rate, which

has risen slowly from less

than 1% in 1990 to 7% in 2006.This is still very low compared to theconventional insurance market, wherethe penetration rate is almost 40%currently.

Given that Takaful contributions inMuslim countries constitute only 1%of the total global insurance premiums,and that Muslims account for 22% ofthe worlds population, there is highpotential for Takafuls global growth.

ReTakaful is a vital part of the Takafulsector to provide risk-mitigatingmechanism, capital relief provision andimportantly, to provide the essentialtechnical capabilities in managing risks.

There are only about 10 to 15 reTakafulcompanies available to support over250 Takaful operators worldwide. Twoare in Malaysia.

Currently, the Takaful industry is still

dependent on conventional reinsurancedue to limited capacity in the reTakafulmarket. Hence, there is a need to buildreTakaful capacity, which would caterto the unique principles of Takaful andcredible reTakaful industry which iscrucial in promoting the expansion ofthe industry worldwide.

Chart 18: Net contributions, 2003 - 2007

13%

14%

14%

16%

16%

87%

86%

86%

84%

84%

25% 29%

27%

28%

22%

75% 71%

73%

72%

78%

Chart 19: Total assets, 2003 - 2007




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Two most commonlyused modelsin Malaysia areMudharabah andWakalah contracts

Operating models in Malaysia

In Malaysia, participants contributea sum of money into a commonfund, which is used to mutuallyassist them against a defined loss.The fund is managed by a Takafuloperator, who runs the operationas an economic venture, deriving

income from investment of theshareholders fund and a share ofthe Takaful fund, agency fees andsurpluses of the Takaful fund.

The operating contract betweenthe participants and the Takafuloperator depends largely on theneeds and preferences of theparties. Malaysia has adopted a

flexible framework for operatorsto choose a suitable model, withthe condition that parameters aredrawn based on Shariah principlesand prudential requirements.However, the future may seesome form of streamlining by theregulators to a common operatingmodel.

The Takaful industry started withtwo operators who adopted theMudharabah (profit-sharing)model, under which Takafulcontracts set out a profit-sharingbasis between operator andparticipant.

The subsequent incorporation of

new operators saw the Wakalah

(agency) operating model beingadopted. The Takaful contractunder Wakalah works on the basisof Wakalah fees being charged.It is generally perceived that theWakalah Takaful contract is simpler.

Regardless of the type of model,

the contract needs to be clearlyworded and transparent to theparticipants in terms of the basisfor charges or profit sharing, otherrelated expenses to be borne by theoperators and/or participants, andthe basis of returns to participantsin the form of Mudharabah or returnof capital.

The distribution channel

The main distribution channelwas the direct marketing channel,comprising the branch networkof Takaful operators and directmarketing.

Over 2004 and 2005, therewas a sharp switch of businessmarketed by the direct channelto bancaTakaful, i.e. distributionthrough banks and other financialinstitutions.

As depicted in Chart 20, Takafulcontributions distributed by directmarketing constituted 61% of

contributions in 2004, and thisfell sharply by 17% to 44% in

2005. Meanwhile, business viabancaTakaful increased from 7%in 2004 to 20% in 2005. Othersignificant channels are the agencyforce (19%) and the broking business(14%).

The growth in the bancaTakaful

channel started primarily from Takafuloperators leveraging on their groupstructure with banking businessesand also strategic alliances formedwith local banks with a wider branchnetwork. More structured andintegrated bancaTakaful distributionarrangements are still in the formativestage in Malaysia.

Chart 20: Contributions bydistribution channels




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Family Takafulovertakes generalTakaful market

Product development andinnovation

At its infancy stage, theTakaful market in Malaysiapredominantly focused onthe general Takaful market. In1990, the composition of netcontributions between general

and family Takaful was 70%and 30%, respectively. In 2007,it was the reverse with familyTakaful net contribution makingup 78% of the Takaful market.The switch in compositionindicates increased retailconsumer awareness towardsTakaful and more effective

distribution channels.Takafuls potential growthlies primarily in family Takafulas evident from the presentmarket penetration rate in theTakaful market of around 5%,compared to the conventionallife insurance rate of almost40%.

Over the years, the compositionof family products offeredhas varied. The breakdown ofnew business contributionsfrom family Takaful is reflectedin Chart 21 while Chart 22shows the distribution ofnet contributions for general

Takaful.

Chart 21: Family Takaful - Distribution ofnew contributions by plan, 2007

Chart 22: General Takaful Distribution by plan, 2007





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Islamic financeproducts &concepts

Islamic bankingIslamic interbank money productsIslamic debt securities (Sukuk)Shariah-compliant equity & indicesShriah-based unit trust fundsOther Islamic investment productsTakaful

Islamic retail products



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Islamic banking

Modern Islamic finance was developed

as an intermediation channel for Muslimsto conduct their savings and investmentactivities in accordance with Islamicprinciples.

Today, over three-quarters of Islamic bankfinancing revolves around three financingconcepts, namely:

Bai Bithaman-Ajil (deferred payment sale)

Ijarah (leasing)Murabahah (cost-plus profit margin)

Bai Bithaman-Ajil

Bai Bithaman-Ajil is a contract for sale ofgoods on a deferred payment basis forproperty, vehicle and financing of otherconsumer goods. Under the scheme, the

property or asset will be purchased bythe financier and sold at an agreed priceonce the tenure and manner of repaymentis agreed upon. The repayment amount isusually fixed throughout the whole period ofcontract.

1.

2.3.

Ijarah

Ijarah is a lease financing structure. In thelease arrangement, the financier leasesequipment, building or other facilities to aclient at agreed rental fees or charges.

In one of the leasing products, Ijarah ThummaAl-Bai, the lease agreement includes thesubsequent purchase of leased asset at theend of the lease tenure.

Murabahah

Under Murabahah, the seller purchasesthe asset at cost and sells it back to thecustomer at a marked-up price agreed to byboth parties. It is an agreement that refersto the sale and purchase transaction for thefinancing of an asset or project, whereby thecosts and profit margin are made known andagreed by all parties involved.



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Islamic interbankmoney products

The IIMM covers theMudharabah interbankinvestment and interbanktrading of Islamic financialinstruments which areessential in managing shortterm liquidity needs of

Islamic banks.

The commonly tradedIslamic interbank moneyproducts in the moneymarket include:

Mudharabah InterbankInvestmentGovernment Investment

IssuesMalaysian IslamicTreasury BillsBank Negara NegotiableNotes-iCommodity Murabahah

Mudharabah Interbank Investment(MII)

MII refers to a mechanism wherebya deficit Islamic banking institution(investee bank) can obtain investmentfrom a surplus Islamic bankinginstitution (investor bank) based on

Mudharabah (profit-sharing). Theinvestment period is from overnightto 12 months, while the rate of returnis based on the rate of gross profitbefore distribution for investmentof one year of the investee bank.The profit-sharing ratio is negotiablebetween both parties.

At the time of negotiation, the investorbank and investee bank will agree tothe profit-sharing rate upfront.

Government Investment Issues (GII)

The Malaysian Government issuesnon-interest bearing certificatesknown as GII to facilitate Islamicbanks purchase of liquid securitiesto meet the statutory liquidityrequirements as well as to park idlefunds. The GII was introduced in July1983 under the concept of Qard Al-Hasan.

Malaysian Islamic Treasury Bills (MITB)

MITB are short-term securities issuedby the Malaysian Government based onBai Al-Inah principle (sale and immediatepurchase). BNM on behalf of theGovernment will sell the Governmentsassets through tender to form the

underlying transaction of the deal. TheMITB price is determined after profitelement is imputed (discounting factor) andissued to successful bidders to representthe debt created in return for the cashreceipt. The bidders will subsequently sellback the assets to the Government at parbased on credit term.

Bank Negara Negotiable Notes-i (BNNN-i)

BNNN-i are Islamic securities issued byBNM using Islamic principles which aredeemed acceptable to Shariah requirement.Issuances of BNNN-i can be either on adiscounted or a coupon-bearing basisdepending on investors demand. Discount-based BNNN-i will be traded using the

same market convention as MITB while theprofit-based BNNN-i will adopt the marketconvention of GII.

Commodity Murabahah

Commodity Murabahah is a sale of certainspecified commodity, at cost plus mark-up.

The Commodity Murabahah Programmelaunched by BNM in 2007 utilises crudepalm oil-based contract as an underlyingasset. CMP provides certainty of returnsas it is undertaken based on pre-agreedmargin or mark-up from the sale andpurchase of the underlying assets.



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Islamic debtsecurities (Sukuk)

Sukuks are Islamicbonds which have similarcharacteristics with aconventional bond with thedifference being that they areasset-backed1and free fromusury (interest).

Sukuks are structured withno interest element. They arelinked to the returns and cashflows of the financing to theassets purchased or the returnsgenerated from the assetspurchased. This is done toavoid trading of debts, whichis prohibited under Shariah.Among the major Sukuk-basedconcepts in Malaysia are:

MusharakahMurabahahIjarahIstisnaa

Musharakah

Musharakah is a partnershipfinancing agreement between twoparties or more to engage in aspecific business activity. All thepartners are entitled to a share inthe profits of a project at a mutually

agreed ratio, while losses areshared in proportion to the amountinvested. In addition, partners whocontribute funds have the right toexercise executive powers in theproject, similar to a conventionalpartnership structure and theholding of voting stocks in a limitedcompany.

Murabahah

Murabahah is a contract of cost-plus profit margin. It involves afinancier acquiring an asset fora purchaser. A price margin isimputed into the sale of the assetfrom the financier to the end

purchaser. Typically, commoditytrade financing is accomplishedwith Murabahah Sukuk.

Ijarah

Ijarah which is equivalent toleasing, involves the transferof the property against theconsideration of periodic rentals.Ijarah arrangement can helpfinanciers create a secondary

market through securitisationof the leased assets. Since thelessor in Ijarah owns the leasedassets, the lessor can sell theassets to a third party whoreplaces the sellers rights andobligations.

Istisnaa

Under Istisnaa (pre-delivery andleasing), the financier providesfunds to the supplier, who agreesto produce, manufacture orconstruct a specific asset. Thefinancier thus acquires the titleof the asset and will sell or leasethe asset back. Manufacturing

and construction financing arecommon projects supported withfinancing via Istisnaa. Istisnaa isalso suited for long term projectfinancing e.g. infrastructureconstruction.

1 Sukuks are linked to the returns and cash flows of the financing to the assets purchased or the returns generated fromthe assets purchased. This is done to avoid trading of debts, which is prohibited under Shariah


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Shariah-basedunit trust funds

Shariah-based unit trust funds

The Shariah-based unit trust funds arecollective investment funds that offerinvestors with the opportunity to invest ina diversified portfolio of Shariah-compliantsecurities managed by professionalmanagers in accordance with Shariah

principles. The schemes are available inmany forms such as Islamic equity funds,bond funds, index funds and others.

With the availability of Shariah-compliantsecurities to facilitate Islamic investment,the Islamic unit trust fund industry hasexperienced significant growth. From onlytwo Islamic funds first introduced in 1993,

the industry today has 134 Islamic funds,representing 26% of the total number of unittrust funds in the country.

Islamic Real Estate Investment Trusts (Islamic REITs)

Islamic REITs are collective investment funds thatpool money from investors to buy, manage and sellreal estate through Shariah-compliant capital marketinstruments. A REIT contract is binding on all investorsthrough a musharakah or partnership structure.

There are currently two Islamic REITs in the market.The first REIT was launched by the healthcare sector,the Al-Aqar KPJ REITs, in 2006 with a fund size ofUS$49 million (RM180 million). The other IslamicREIT is the Al-Hadharah Boustead REIT which madeits debut in 2007 with US$67 million (RM230 million)raised.

Islamic structured investment products

Structured investment products are syntheticinvestments which can be an alternative to directinvestments, as part of the asset allocation processto reduce risk exposure of a portfolio or to leveragecurrent market trends. Similar to its conventionalcounterpart, Islamic structured investment productshave become an increasingly important investmenttool for both investors and wealth managers.

A new addition to Islamic structured investmentproducts is the CIMB Islamic All-Stars GlobalRestricted Mudharabah Structured Investment. Thestructured investment product combines 100% capitalprotection, if held to its five-year maturity period, withreturns linked to the performance of 20 global blue-chip MNCs.

Islamic stockbroking services

Islamic stockbroking services began in 1994.Currently, there are three players which provide bothconventional and Islamic stockbroking services.Given the growing investor demand, several moreconventional stockbrokers are expected to offerIslamic stockbroking services soon.

Other Islamicinvestment products



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Takaful

Takaful is an insurance conceptin Shariah whereby a groupof participants mutuallyagree among themselves toguarantee each other againstdefined loss or damage thatmay be inflicted upon any ofthem by contributing as tabarru

or donation to the Takaful fundsoperated by a Takaful operator.It emphasises unity and co-operation among participants.

Tabarru (donation, gift orcontribution) is the core of theTakaful system that makes theuncertainty element allowable

under the Takaful contract.

General Takaful

General Takaful refers to Takaful schemefor short-term basis, usually 12 months,to compensate its participants for anymaterial loss, damage or destruction theymight suffer arising from a misfortune thatmight be inflicted upon their properties orbelongings.

If at the end of the period there is anet surplus in the general Takaful fund,the surplus shall be shared betweenthe participants and the operatorin accordance with the principle ofMudharabah. This is provided that theparticipant has not incurred any claimsand/or received any benefits under the

general Takaful certificate.

Family Takaful

The family Takaful plan is a combinationof long-term investment and mutualfinancial assistance scheme similar to theconventional life insurance. The objectivesof this plan are to save regularly to earn

investment returns in accordance withIslamic principles and to obtain coveragein the event of death prior to maturity froma mutual aid scheme. Each contributionpaid is credited into two separate accountsfor contribution and savings or investment.



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Islamic retail products

Malaysia offers a comprehensive array of Islamic financialproducts and services, onshore and offshore, ranging fromretail to wholesale banking, Takaful, money as well as capitaland bond markets.

Islamic banking products Takaful products Investment products

Financing

Hire purchaseCash line facilityShare financing

LeasingFixed asset financingTerm financingWorking capital financingRevolving credit facilityEquipment financingProject financingContract financingJoint venture

Bridging financingExport credit refinancing

Trade Financing

Letter of creditAccepted billTrust receiptBank/shipping guarantee

Inward/outward bills for collectionMulti-currency trade financing facilityIndirect exported financing scheme

Family Takaful

Endowment TakafulMedical and health TakafulInvestment-linked Takaful

Education plan TakafulMortgage TakafulAnnuity TakafulTravel Takaful

General Takaful

Motor TakafulFire Takaful

Personal accident TakafulEngineering TakafulMarine, aviation and transit TakafulContractors all risks andengineering TakafulLiability TakafulWorkmen compensation Takaful

Shariah-compliant stocksShariah-based unit trust fundsIslamic REITsIslamic structured investmentproducts

Islamic stockbroking services




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Regulation &tax incentives

Regulation & supporting frameworksTax incentives


R l i &


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Regulation &supportingframeworksMalaysia has taken anintegrated approachto the regulation and

supervision of Islamicfinance, catering to theunique characteristicsof Islamic financeoperations

The regulatory

framework is robustand comprehensive,accommodating anIslamic financial systemthat operates in parallelwith the conventionalsystem

Regulatory framework

Regulation

The Malaysian Islamic financeexperience has been unique. Malaysiahas successfully developed anIslamic financial system that operatesin parallel with its conventionalcounterpart. For example, whileIslamic banking in Malaysia is

governed by its own legal framework(Islamic Banking Act 1983), it is alsosubjected to a similar regulatory andsupervisory framework as that ofconventional banking.

In the Malaysian Islamic bankinglandscape, there are full fledgedIslamic banks as well as conventional

banking institutions with an Islamicbanking window that offers Islamicproducts and services.

Licensing and supervision

The licensing and regulation ofIslamic banking institutions andTakaful operators in Malaysia aregoverned by the Islamic Banking Act

1983 and Takaful Act 1984 as well asthe Banking and Financial InstitutionsAct 1989 and Development FinancialInstitutions Act 2002. These Acts fallunder the purview of BNM, whichregulates and supervises the Islamicbanking and Takaful sectors.

In the Islamic capital market, SC isresponsible for issuing licences tomarket intermediaries and guidelineson the offering of Islamic securities1.

Shariah Advisory Council

To ensure that all Islamic capitalmarket products comply withthe Shariah principles, BNM andSC have both established theirrespective Shariah Advisory Council(SAC). The SAC comprises prominentShariah scholars, jurists and marketpractitioners. Their role is to advise

regulators on matters relating toIslamic financial markets and provideShariah guidance on Islamic financialproducts, services, transactions andactivities.

BNM SAC2is the central ShariahAuthority in Islamic banking andTakaful. Its roles include issuing

fatwa3

to be implemented byIslamic bank and Takafuls ShariahCommittee and reference point forShariah Committee on Shariah issuesin relation to product and operations.

The SCs SAC4serves as a singlepoint of reference on Islamic capitalmarket (ICM), providing guidance toall participants in the ICM on matters

pertaining to Shariah compliance.

As part of the ongoing initiativesto build good Shariah governanceamong Islamic financial institutions,both banks and Takaful are requiredto establish Shariah Committee.The purpose of the committee is toadvise Islamic financial institutions on

the shariah compliance in all aspectsof its operations.

1 Provided under the Securities Commission Act, 1993 and Capital Market and Services Act 20072 BNMs SAC was established on 1 May 1997 under the Central Bank Act 19583 Fatwa Islamic rules derived from Quran and Sunnah

4 SCs SAC was set-up on 1 July 1996 under the Securities Commission Act 1993


Chart 23: Malaysias Islamic financial system operates in parallel with conventional system


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Acronyms:

AAOIFI Accounting & Auditing Organisation for Islamic Financial InstitutionsBIS Bank for International SettlementsIAASB International Auditing & Assurance Standards BoardIASB International Accounting Standards Board

IDB Islamic Development BankIFSB - Islamic Financial Services Board

Chart 23: Malaysia s Islamic financial system operates in parallel with conventional system

IIFM -International Islamic Financial MarketIMF International Monetary FundIOFC International Offshore Financial CentreIOSCO - International Organisation of Securities Commissions

MIFC - Malaysian International Islamic Financial Centre


Supporting framework


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Supporting framework

Tax

In efforts to facilitate the Islamicfinance market and transactionsin Malaysia, the Government hasmade changes to the tax regimeto streamline the tax structure onIslamic finance transactions.

Under this tax neutrality

framework, amendments weremade to the Income Tax Act1967, the Real Property GainsTax Act 1976 and the Stamp Act1949. Under the tax neutralityframework, additional instrumentsand transactions executed tofulfill Shariah requirements areexempted from additional stamp

duty and tax payment.

Sovereign Sukuk

The Government InvestmentAct 1983 and the GovernmentFunding Act 1983 were enactedto facilitate the developmentof the government Sukuks

in accordance with Shariahprinciples. This in turn has helpedto provide liquidity in the Islamicinterbank market through short-term Government Islamic notesbenchmark returns for corporateSukuks and established themarket for Malaysia to raiseinternational Sukuks.

Unique characteristics ofShariah Islamic financing

Shariah is the key pillar of Islamic financefrom which Islamic finance derives its uniquecharacteristics. The Shariah injunctions require thatIslamic financial transactions be accompanied by

an underlying productive activity. In Islamic finance,there is always a close link between financial andproductive flows.

In addition, under the required risk sharing principle,Islamic financial institutions will share the profitor the loss incurred by the entrepreneur. There isan explicit sharing of risk by the financier and theborrower. This arrangement will thus entail the

appropriate due diligence and the integrating of therisks associated with the real investment activityinto the financial transaction. In this arrangement,the real activity is expected to generate sufficientwealth to compensate for the risks.

In contrast, conventional instruments generallyseparate such risks from the underlying assets. As aresult, risk management and wealth creation may, at

times, move in different or even opposite directions.Conventional financial instruments also allow forthe commoditisation of risks. This has led to itsproliferation through multiple layers of leveragingand disproportionate distribution, which in turn,could result in higher systemic risks, thus increasingthe potential for instability in the financial system.


Chart 24: Islamic finance regulatory and supporting frameworks


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Regulatory Framework

Islamic finance

institutionsIslamic capital market Tax Government sukuk

Regulatorybodies Bank Negara Malaysia


Malaysia

Inland Revenue Board;

Royal Malaysian

Customs

Ministry of Finance;

Bank Negara Malaysia

National Shariah

Advisory Council

Shariah Advisory

Council

Tax neutrality

framework

Issuance ofsovereign Sukuk

Islamic Financial

Services Board(IFSB)

Accounting & Auditing

Organisation forIslamic Finance

Institutions (AAOIFI)

International

Islamic FinancialMarket (IIFM)

Malaysian International

Islamic FinancialCentre (MIFC)

Labuan Offshore

Financial ServicesAuthority (LOFSA)

Other

regulatory and

developing

bodies

Islamic Banking Act 1983

Takaful Act 1983

Development Financial

Institutions Act 2002

Central Bank Act of

Malaysia 1958

Income Tax 1967

Real Property Gains

Tax Act 1976

Stamp Act 1949

Government

Investment Act 1983

Government Funding

Act 1983Legal Acts


Act 1993

Capital Market andServices Act 2007

Supporting Framework

C g y pp g


Other regulatory and


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g ydeveloping bodies

Labuan Offshore Financial ServicesAuthority (LOFSA)

LOFSA was established as a singleregulatory agency4responsible forsetting national objectives, policiesand priorities for the developmentand administration of the Labuan

International Offshore FinancialCentre (IOFC).

LOFSAs role is pivotal in developingoffshore Islamic banks and Takafuloperators as well as supervisingactive primary and secondarymarket for listing and trading ofoffshore Islamic instruments throughthe Labuan Financial Exchange.

Malaysia International IslamicFinancial Centre (MIFC)

MIFC5was formed as part of theMalaysian Governments initiative toposition Malaysia as an internationalIslamic financial centre. MIFCcomprises a diversified range of

financial institutions operating fromanywhere in Malaysia, offeringIslamic financial products andservices in any currency to non-residents and residents.

The MIFC Executive Committee(Committee) acts as a singlecoordinating body to provide

direction and ensure smoothimplementation and efficient deliveryof MIFC-related initiatives. TheCommittee is assisted by the MIFCSecretariat, which acts on behalf ofthe Committee to coordinate andimplement the MIFC initiatives.

International Islamic FinancialMarket (IIFM)

The establishment of the IIFM,an infrastructure institutionwhich is based in Saudi Arabia,provides the market mechanismfor the advancement and

standardisation of Islamicfinancial instruments and theissuance of guidelines andrecommendations for theenhancement of Islamic capitaland money market globally.

Islamic Financial Services Board(IFSB)

IFSB6is an internationalstandard-setting organisationthat promotes and enhances thesoundness and stability of theIslamic financial services industryby issuing global prudentialstandards and guiding principlesfor the industry. This includes

the banking, capital markets andinsurance sectors.

Since its inception, the IFSBhas issued seven standards:guiding principles and technicalnote for the Islamic financialservices industry focusingon risk management, capitaladequacy, corporate governance,

supervisory review process,transparency and marketdiscipline, recognition of ratingson Shariah-compliant financialinstruments as well as thedevelopment of Islamic moneymarkets.

Accounting & Auditing Organisationfor Islamic Finance Institutions(AAOIFI)

AAOIFI7was established inBahrain to address accountingissues concerning Islamic financialinstitutions. To date, AAOIFI has

issued 70 standards on accounting,auditing, governance, ethics andShariah standards. The standardsare currently in use in some Gulfstates and selectively in othercountries.

Professional bodies

Several institutions of higher learningand centres of research and study ofall relevant areas of Islamic banking,finance and economics have beenestablished in order to increasethe necessary pool of talent for theindustry:

The International Centre forEducation in Islamic Finance

(INCEIF) provides professionalcertification and post-graduatestudies in Islamic finance

The Islamic Banking and FinanceInstitute Malaysia (IBFIM) offerstechnical courses in Islamicbanking and finance

The International Centre for

Leadership in Finance (ICLIF)provides leadership developmentand management training forfinancial institutions includingIslamic financial institutions

The International ShariahResearch Academy for IslamicFinance (ISRA) promotes applied

research in the area of Shariahand Islamic finance

4 LOFSA was established on 15 February 1996. 5 MIFC was unveiled on 14 August 2006.6 IFSB commenced operations on 10 March 2003. 7 AAOIFI was established on 26 February 1990.



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Tax


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Tax

incentivesIn line withthe MalaysianGovernments effortsto promote Malaysiaas an InternationalIslamic financialcentre, substantialtax incentives havebeen provided inthe area of IslamicFinance

Tax exemption ofIslamic banks andTakaful companies

10-year tax exemption to Islamic banks andIslamic banking units licensed under theIslamic Banking Act 1983 on income derivedfrom Islamic banking business conductedin international currencies, includingtransactions with Malaysian residents; and

10-year tax exemption to Takaful companiesand Takaful units licensed under theTakaful Act 1984 on income derived fromTakaful business conducted in internationalcurrencies including transactions withMalaysian residents.

These incentives are effective from YA 2007to YA 2016.

Exemption fromwithholding tax

Effective 2 September 2006:

Profits received by non-residents fromfinancial institutions established under theIslamic Banking Act 1983, and other financialinstitutions approved by the Minister ofFinance be exempt from tax as well. This is tostreamline tax treatment on profits received

by foreign non-resident customers from allfinancial institutions

Any profits paid out by an Islamic bank toforeign non-resident customers need not besubject to tax in Malaysia, thus providing equaltreatment with conventional banks foreigncustomers. This means that there will be nowithholding tax on profit payments made by

all licensed banks in Malaysia to non-residentcustomers.



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Facilitation offinancingtransactions

The definition of partnership for tax purposeis very wide and includes all types ofpartnerships. Hence, any type of partnership,unless specifically excluded, would have to filetax returns.

In recognising and promoting Islamicfinancing structures based on the concept ofMusharakah or Mudharabah, such financingtransactions need not file partnership taxreturns.

This is effective from YA 2007.

Tax exemption

of fund managers

Effective from YA 2008 YA 2016:

10-year tax exemption for local and foreigncompanies managing funds established underthe Shariah principles and approved by SC.

Real EstateInvestment Trusts(REITs)

REITs have also been provided with furtherboost through several tax initiatives:

So long as REITs distribute at least 90% ofincome to investors, the REITs will not have to

pay tax.Distributions to certain investors will besubject to reduced tax for five years, namely:

Non-corporate investors, including residentand non-resident individuals, that receivedividends from approved REITs, be subjectto a final withholding tax of 15%; andForeign institutional investors, especiallypension funds and collective investment

funds, that receive dividends fromapproved REITs, be subject to a finalwithholding tax of 20%.

Corporate investors (resident and non-resident)will continue to be subject to normal corporateincome tax at 26% (to be reduced to 25% fromYA 2009).



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Human capital In encouraging Malaysians to explore Islamicfinance as a career choice, tax relief notexceeding RM5,000 (US$1,552) p.a. is alsoprovided on Islamic finance courses approvedby BNM or SC at local institutions.

Extension of taxdeduction on issuancecosts of Islamicsecurities

Extension of three years to 2010, taxdeduction on the expenses incurred on theissuance of Islamic securities based on Ijarah,Istisnaa, Mudharabah, Musharakah and otherIslamic securities.

Stamp duty Further stamp duty exemption of 20% oninstruments used in Islamic financing productsapproved by the SAC of BNM or SC for a

period of three years, up to 31 December2009. This means that Islamic transactions willsuffer less stamp duty by 20% compared toconventional financing instruments.

100% stamp duty exemption for 10 years upto 31 December 2016 on foreign currencyinstruments executed by InternationalCurrency Islamic financial institutions.

Others Other tax initiatives include:

Pre-commencement expenses of an Islamicstockbroking business will be allowed as taxdeduction so long as business is commencedwithin two years from approval by SC.Applications have to be received by SC from2 September 2006 to 31 December 2009.

Special purpose vehicles established solelyfor the purposes of issuance of Islamicbonds need not be subject to tax or taxadministrative procedures, subject to certainconditions.


PwC Malaysia



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PwC MalaysiaIslamic FinanceServices

With the enhanced focus and expansionof Islamic finance to all areas of financialservices globally, it becomes increasinglyimportant to have advisors who can applytheir knowledge to products and servicesrelating to Islamic finance locally and globally.

The PwC Malaysia Islamic Finance team hasbeen at the forefront of Islamic finance andbanking developments in Malaysia, workingwith regulators to achieve their strategy toevolve Malaysia as an integrated internationalIslamic banking and financial hub. Our Islamic

finance team has performed audit reviews,and provided advisory services and taxadvice to local and international banks andregulatory bodies.

Besides being a Partner of PwC Malaysia,Mohammad Faiz Azmi is also the PwC GlobalLeader in Islamic Finance, leading the Global

Islamic Finance Team (GIFT) with teammembers in Kuala Lumpur, Dubai, Bahrainand London. GIFT acts as a coordinating unitto manage PwCs service offering globally inareas as diverse as new setups, structuredproducts, Sukuk taxation and marketresearch.


Global reach, local knowledge


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Global reach, local knowledge

Connect with us for these services:

Start-up support for new entities or ventures in banking,Takaful or capital market relatedStrategy and business planningTransaction support on acquisition of assets or entitiesStatutory audits and tax advisory

Accounting and taxation support on structures andproducts such as SukuksProcess improvement of banks and Takaful operatorsBasel II work in relation to the implementation of IFSBCapital Adequacy StandardInternal audit training and Shariah auditsTraining on subjects such as AAOIFI standardsFeasibility studies and business plansLicensing and legal vehicle assessment and selection

Licence application and other regulatory approvalInventorise and advise on local regulatory obligations andexpectations of local regulatorsDevelop and implement local compliance requirements,including standards, policies and procedures

We can assist foreign clients in the following areas:

Application of licences:

International Islamic Banking licenceInternational Takaful Operator licenceFeasibility studies

islamic finance hub

Documents