Chapter 6: Islamic Investment Business PDF

CHAPTER SIX Islamic Investment Business  DISCLAIMER □ Brunei Darussalam Central Bank (BDCB) is not responsible for the results of any action taken on the basis of information in this licensing examination study manual or any errors or omission; □ BD...

CHAPTER SIX Islamic Investment Business  DISCLAIMER □ Brunei Darussalam Central Bank (BDCB) is not responsible for the results of any action taken on the basis of information in this licensing examination study manual or any errors or omission; □ BDCB expressly disclaim all and any liability to any person in respect of anything and of the consequences of anything done or omitted by a person in reliance, whether whole or partial, upon the whole or any part of the contents of this licensing examination study manual; and □ BDCB do not purport to provide legal or other expert advice in this licensing examination study manual and if any legal or other expert advice is required, the services of a competent professional person should be sought.  ABBREVIATIONS AMBD Autoriti Monetari Brunei Darussalam AAOIFI Accounting and Auditing Organisation for Islamic Financial Institutions BDCB Brunei Darussalam Central Bank BDCBO Brunei Darussalam Central Bank Order, 2010 BOD Board of Directors CMSL Capital Markets Services Licence CMSRL Capital Markets Services Representative’s Licence CIS Collective Investment Scheme CFD Contracts for Differences CSD Central Securities Depository ECF Equity Based Crowdfunding FCA Financial Conduct Authority FIMM Federation of Investment Managers Malaysia FinTech Financial Technology IOSCO International Organization of Securities Commissions IFRS International Financial Reporting Standards IMF International Monetary Fund ISAF Internal Syariah Audit Framework ICM Islamic Capital Market MMOU Multilateral Memorandum of Understanding OTC Over the Counter P2P Peer-to-Peer SMO, 2013 Securities Markets Order, 2013 SMR, 2015 Securities Markets Regulations, 2015 SFSB Syariah Financial Supervisory Board SFSBO Syariah Financial Supervisory Board Order, 2006 SRO Self-Regulating Organisation SAB Syariah Advisory Body SGF Syariah Governance Framework SPV Special Purpose Vehicle Contents CHAPTER 6 – ISLAMIC INVESTMENT BUSINESS...............................................................2 Learning Goals........................................................................................................................2 6.1 Background.......................................................................................................................2 6.2 Applying to conduct Islamic investment business..............................................................4 6.3 Conducting Islamic investment business............................................................................5 6.3.1 General requirements..................................................................................................5 6.3.2 Specific requirements.................................................................................................6 6.4 Approval of Islamic financial product................................................................................8 6.5 Implementing a Syariah Governance Framework...............................................................9 Summary............................................................................................................................... 10 Looking ahead....................................................................................................................... 11 Questions............................................................................................................................... 12 Additional recommended reading.......................................................................................... 13 Appendix 1 - Additional notes on Implementing an Internal Syariah Audit Framework......... 14 1  CHAPTER 6 – ISLAMIC INVESTMENT BUSINESS Learning Goals LG1. To define the Islamic investment business and the forms through which it may operate. LG2. To outline the roles of the Syariah Financial Supervisory Board (SFSB) and the Syariah Advisory Body (SAB). LG3. To outline the key requirements in applying for an endorsement to carry on an Islamic investment business. LG4. To describe the key requirements in conducting an Islamic investment business. LG5. To outline the key requirements in seeking for approval to offer an Islamic financial product. LG6. To describe the key requirements for implementing a Syariah governance framework. 6.1 Background Islamic investment business has been growing rapidly due to both religious and business considerations. It appeals to those who may feel more comfortable to deal in ways that closely align with their religious beliefs which prohibits dealing with riba or interest. It also appeals to others who may prefer or opt for Islamic investment products because they provide alternative choices and have unique features which directly promote real economic activities and thus possess stronger resilience to market shocks as proven during the global financial crisis in 2007 to 2008. This activity is regulated under the Syariah Financial Supervisory Board Order, 2006 (SFSBO) and the Securities Markets Order, 2013 (SMO). The SFSBO establishes the Syariah Financial Supervisory Board (SFSB) and provides for the governance of financial institutions’ dealings in Islamic financial products and services. The Syariah Financial Supervisory Board (SFSB) was established as the national authority that determines the Laws of Islam for the Islamic financial sector who operates its business based on Syariah principles. This includes Islamic banking business, takaful business, and any other business including Islamic investment business. The SFSB has three (3) main mandates: (1) To act as the authority to ascertain the Laws of Islam for the purposes of Islamic financial businesses which is based on Syariah principles and which is supervised and regulated by the Authority; 2 (2) To approve Islamic products submitted by financial institutions; and (3) To approve appointments of any person to become a member of any SAB or to act as a Syariah consultant or Syariah advisor of the financial institution. The SFSBO allows the Chairman of the SFSB to appoint any person as the Secretary of the Board. By virtue of this provision, the SFSB has appointed a senior officer from BDCB as the Secretary who is also supported by a Secretariat staffed by BDCB officers. The Secretariat handles all applications that require SFSB’s approval. The Secretariat also has a responsibility to manage the issuance of notices within the power of Brunei Darussalam Central Bank Order, 2010 (BDCBO) which supplements the requirements under the SFSBO and provide guidance on how to comply with these requirements. The relevant requirements that apply to Islamic investment business will be explained in more detail in the later part of this Chapter. Fundamentally, the SFSBO requires financial institutions (including capital markets services firms or market operators) to obtain the SFSB’s approval for Islamic financial products and services. It also requires capital markets services firms or market operators that intend to appoint any Syariah advisory body, Syariah consultant or Syariah advisor to obtain approval from the SFSB. Any financial institution which fails to comply with or contravenes the provisions under the SFSBO is guilty of an offence and liable on conviction to a fine, imprisonment or both. Section 23 of the SMO defines conducting Islamic investment business as carrying on one or more of the regulated activities provided in the Schedule as explained in Chapter 3 such as dealing in investments and managing securities which are in accordance with Hukum Syara’. An Islamic investment business may be carried on in one of the two (2) forms below: (1) As an Islamic investment institution: whereby the entire business operations of the CMSL holder or market operator is conducted according to Hukum Syara’, or (2) As an Islamic window: whereby the Islamic investment business is conducted by the CMSL holder or market operator as part of its overall business operations. For example, Company B who is a conventional broker or dealer also offers dealing in Islamic securities within the same company. A CMSL holder or market operator that takes on one of these two (2)forms is called an Islamic Capital Market Participant (ICM Participant). In the first form, the entity does not engage in 3 conventional investment business and conducts Islamic investment business exclusively. In the second form, the entity may engage in both conventional and Islamic investment businesses. In order to conduct Islamic investment business, an entity needs the Authority’s permission to carry out this business through one of the following three (3) ways: (1) The Authority grants an endorsement to the entity’s licence; (2) The Authority grants an endorsement to the entity’s recognition; or (3) The Authority exempts an entity from the SMO requirements for conducting an Islamic investment business. A capital markets services firm or market operator which has this endorsed licence needs to appoint its Syariah Advisory Body (SAB) and obtain the SFSB’s prior approval for every single regulated activity. The SAB is a body whose role is to “review, advise, give opinion(s) and approve Islamic product(s) and any Syariah-related operations and activities to ensure that they comply with Syariah principles” (BDCB, 2017a, p4). 6.2 Applying to conduct Islamic investment business In order to apply for endorsement to conduct Islamic investment business, an entity should refer to the Guideline on Application to Carry on Islamic Investment Business provided by BDCB (2017a). The applicant should submit a working paper that contains the following information and documents: (1) The applicant’s objectives; (2) The proposed regulated activity or activities; (3) Arrangements/alliances with third parties such as the form of the arrangement, key terms and cost-benefit considerations, information on the third party, reason for the arrangement, potential risks and mitigation factors; (4) How the applicant will equip its resources and infrastructure; (5) Description of the Syariah governance including the SAB members and their CVs; (6) Description of the major operations including Syariah concepts and mechanisms, that have been approved by the SAB; (7) Description of the compliance function’s role in implementing the Syariah governance process; and 4 (8) A copy of the endorsement or resolution by the SAB and the Board of Directors (BOD) that they have resolved for the applicant to carry on the Islamic investment business. 6.3 Conducting Islamic investment business Upon receiving an endorsement of licence to conduct Islamic investment business, a CMSL holder who wishes to conduct the regulated activities of dealing and arranging deals in Islamic securities should refer to Guideline on Conducting Islamic Investment Business – Dealing and Arranging Deals in Investments provided by BDCB (2017b). This Guideline provides guidance to CMSL holders in terms of how they should conduct these activities and sets out the general and specific requirements on, among others, operations, systems and procedures. 6.3.1 General requirements Some of the key general requirements are as follows: (1) Memorandum and Articles of Association: The memorandum and articles of association of the ICM Participant should state that its business activities or operations aim to achieve the ICM Participant’s commercial objectives which adhere to Hukum Syara’. It should also state that the ICM Participant is allowed to undertake certain trading activities which are based on Hukum Syara’ in order to facilitate Syariah compliant transactions. For an Islamic window, the memorandum and articles of association should allow and not explicitly restrict the carrying of its Islamic investment business. (2) Management’s responsibility: The BOD and senior management are ultimately responsible for ensuring compliance with Hukum Syara’, the SMO, and the Authority’s directions and guidelines. (3) Employee’s competency: The ICM Participant should ensure that it has adequate employees with the necessary qualification, expertise and experience for its business. It should provide adequate and sufficient training to its employees. The compliance officer, in particular, should be well versed on the business activities of the ICM Participant and have adequate Syariah knowledge on Islamic finance and capital markets. (4) Compliance Officer: The ICM Participant should appoint a Compliance Officer who is responsible to: 5  a. Ensure the business operations comply with Hukum Syara’, the SMO, and the Authority’s guidelines and directions, b. Report non-compliance to the SAB, BOD and the Authority; and c. Assist the SAB to prepare and certify that the business activities are carried out according to Hukum Syara’ (5) Outsourcing: Any Compliance function should have at least one local compliance officer appointed to perform the compliance function. The local compliance officer is responsible to provide regular compliance reports to the SAB, BOD and senior management. (6) Written disclosure and declaration: The ICM Participant should provide an annual written declaration as endorsed by the SAB and the BOD that its business activities are carried out in accordance with Hukum Syara’, the SMO, and the Authority’s directions and guidelines. (7) Internal Audit: The internal auditor is responsible to monitor Syariah compliance in accordance with the SMO, this Guideline, and the Authority’s directions and other guidelines. Any non-compliance should be reported by the internal auditor directly to the SAB and BOD for consideration and immediate remedial action. This should also be reported to the Authority. Further requirement on putting the necessary internal Syariah Audit Framework is provided for reference in Appendix 1 of this Chapter. (8) Advertisement: The ICM Participant should also put in place internal policies in relation to advertisements which have been approved by its SAB and BOD. 6.3.2 Specific requirements This Section outlines this Guideline’s key specific requirements in conducting Islamic investment business. This Guideline requires the ICM Participant to establish and implement adequate policies, systems, operational procedures and internal controls in relation to its daily business operations and activities to ensure compliance with Hukum Syara’. This includes the following: (1) In preparing and maintaining all financial accounts and statements, the ICM Participant must comply with the International Financial Reporting Standard (IFRS) and supplemented by the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) Standards, where applicable; (2) All charges and fees imposed on transactions and services provided by the ICM Participant to its clients or customers should be approved by the SAB and BOD; 6 (3) In terms of dealing and arranging deals in investments in local Islamic securities, only securities which are approved by the SAB and SFSB are allowed. For investments in foreign Islamic securities, only those which are approved by the SAB are allowed. However, if the foreign securities are to be distributed in Brunei, the ICM Participant also needs SFSB’s approval; (4) In maintaining the banking account, the ICM Participant is encouraged to maintain its banking accounts at an Islamic bank. Regardless of whether these accounts are for the ICM Participant itself or for its clients, the bank accounts should not accrue or be attributed with interest. The ICM Participant should also protect the clients’ monies and assets according to Hukum Syara’, the SMO, and the Authority’s guidelines and directions; (5) Outsourcing of any important operational functions, for instance, Syariah audit, Syariah compliance and review function, are allowed but must not impair the quality of its internal control and the Authority’s ability to supervise the entity’s compliance with the SMO, guidelines and directions. There must be written and binding agreements with the service providers to formalise the outsourcing arrangements; (6) As to the purification of non-permissible revenue, the entity must have suitable policies in place on purification that have been approved by the SAB and BOD. Purification is the process of removing tainted income due to interest earned or Syariah non-compliant activity where the tainted income will be channelled to charity according to the advice of the SAB. (7) Any risk management arrangements, policies and procedures should address Syariah operational and compliance risk; (8) An ICM Participant should ensure that proper segregation of funds is maintained where funds from non-Islamic securities dealing activities must be segregated from those pertaining to Islamic securities. In addition, the ICM Participant operating an Islamic window should ensure the trading accounts are clearly tagged and used specifically for its purposes, i.e. Islamic securities or general purposes; (9) The system used by the ICM Participant should facilitate and support the conduct of activities and operations. In addition, the ICM Participant operating an Islamic window should have systems and controls that ensure clear separation of Islamic business activities from conventional business activities; 7 (10) The entity should put in place appropriate standard operating procedures that are approved by the SAB and BOD; and (11) The ICM Participant should also put in place internal policies on Zakah contribution that are approved by the SAB and BOD. Zakah, which means “to purify or cleanse”, is the third pillar of Islam. It is a financial contribution obligated to those who possess wealth that has reached a prescribed amount being maintained in their possession for one lunar year. Such financial contribution are then disbursed to specified recipients that is prescribed by Syariah. On this note, the Guidelines on Syariah Governance Framework for Financial Institution in Brunei Darussalam outline the SAB’s duties, responsibilities, and areas of accountability. This includes providing advice on Zakah and Syariah non-compliant income matters. Hence, any matters relating to Zakah such as its calculation methodology and distribution will be scrutinised by the ICM Participant’s SAB. 6.4 Approval of Islamic financial product Prior to any offering of Islamic financial services or product including securities, an ICM Participant must obtain the approval of the SFSB. The Notice on Application Process of Islamic Product sets out the requirements on the application process of Islamic products. This Notice supersedes the Guidelines on the Islamic Product Approval Process under Section 14 of the Syariah Financial Supervisory Board Order 2006. Such application needs to be submitted to the Secretary of the SFSB. The Notice outlines the different requirements depending on the nature and the circumstances of the application. For instance, an applicant has to comply with the requirements under Appendix 1 of the Notice if the application relates to: (1) A new Islamic product that is not structured according to the Authority’s Syariah Standard; or (2) A change of Syariah concept of an existing Islamic product that is not structured according to the Authority’s Syariah Standard. 8 Meanwhile, the requirements under Appendix 2 shall apply to any of the following circumstances: (1) A new Islamic product structured using the Authority’s Syariah Standard; or (2) A change of Syariah concept of an existing Islamic product that is structured according to the Authority’s Syariah Standard; or (3) A variation(s) to an existing Islamic product that results in a material change to the structure, features, or risk profile. Once the completed application has been submitted, the Authority shall notify the applicant on the result of the application within a period of forty (40) working days or such extended time considering the complexity of the Islamic product being submitted. There may be instances where variation of an existing Islamic product constitutes immaterial changes to the structure, features or risk profile. In such instances, the applicant must inform the Authority within 30 calendar days before re-launching of the Islamic product. Further information on the requirements are stated in the Notice. 6.5 Implementing a Syariah Governance Framework All Islamic financial institutions including ICM participants are required to put in place a Syariah Governance Framework (SGF) as provided under the Notice and Guidelines on Syariah Governance Framework. The SGF covers the roles and responsibilities of the BOD, the SAB and the management to ensure that all its operations and business activities are in accordance with Hukum Syara’ and that the ICM Participant has an effective oversight of Syariah compliance. This includes the conduct of Syariah research, Syariah review, Syariah audit and Syariah risk management on a continuous basis. The comprehensiveness of the SGF of the ICM Participant should be commensurate with the size of its business. The ICM Participant is encouraged to adopt the principles set out in the Guidelines on SGF based on the “comply” or “explain” basis. 9 The main requirements are as follows: (1) The BOD will be responsible for the establishment of an appropriate Syariah governance structure to oversee the Syariah compliance aspects of the ICM Participant’s overall operations; (2) The ICM Participant is required to establish or appoint a SAB that is responsible to review, advise, give opinions and approve all Islamic products and services and to ensure the overall business and operation of the ICM Participant comply with Hukum Syara’; (3) Within a group which consists of multiple Islamic financial institutions (such as an Islamic bank, Takaful operator and ICM Participant), each Islamic financial institution must establish a SAB. However, all the Islamic financial institutions may utilise a single SAB subject to approval by the Authority; (4) Every financial institution should establish a Syariah Department and Syariah compliance function whose responsibilities are, amongst others, to ensure its overall operations including the Islamic products and services being offered to customers comply with Hukum Syara’. The SAB may delegate its powers and authority to the Syariah Department; and (5) In addition to the above, the ICM Participant may establish Syariah control functions which comprise Syariah Research, Syariah Review, Syariah Audit and Syariah Risk Management. The SAB may also delegate its powers and authority to the Syariah control functions. Further information on the requirements are available in the Notice and Guidelines of the Syariah Governance Framework. Summary This chapter began by outlining what an Islamic investment business is. It is one whose regulated activities are listed in the SMO’s Schedule and adheres to Hukum Syara’. Islamic investment business may be carried on in the form of an Islamic investment institution or an Islamic window. All Islamic investment business requires prior approval from the Authority and SFSB. The SFSB was established to determine the Laws of Islam pertaining to, among others, the Islamic investment business. All financial institutions may seek the SFSB’s advice on Syariah matters. The SFSB appoints a Secretary supported by a Secretariat under BDCB. The Secretariat handles 10 all applications that require SFSB’s approval, issues notices and guidelines that supplement the SFSBO’s requirements and provide guidance on how to comply with the requirements. Meanwhile, all ICM Participants must establish their own SAB to advise on and ensure compliance with Syariah principles. This chapter also outlined the key items stated in the pertinent guidelines pertaining to: (1) Informational requirements when applying for the Authority’s endorsement; and (2) The conduct of regulated activities of dealing and arranging deals. The latter details both the general and specific requirements. Prior to offering any Islamic financial product or services, an ICM Participant must obtain the SFSB’s approval. The applicant process requirements differ based on the nature and circumstances of the application, for instance whether the application relates to: (1) A new Islamic product that is or is not structured according to the Authority’s Syariah Standard; or (2) A change of Syariah concept of an existing Islamic product that is or is not structured according to the Authority’s Syariah Standard; or (3) A variation(s) to an existing Islamic product that results in a material change to the structure, features, or risk profile. An ICM Participant must also implement an SGF that covers the roles and responsibilities of the BOD, the SAB and the management. This is to ensure that all its operations and business activities comply with Hukum Syara’ and that it has an effective Syariah compliance oversight. Looking ahead The next chapter discusses the Public Offering processes. 11 Questions 1. Define what Islamic investment business is. 2. What are the two (2) forms through which Islamic investment business may be operated? How do they differ? 3. What are the roles of the Syariah Financial Supervisory Board and the Syariah Advisory Body? What are the differences? 4. Can an entity conduct Islamic investment business in collaboration with an external third party? Why or why not? If yes, what are the requirements? 5. What type of permission is given by the Authority to conduct Islamic investment business? Who handles the applications that are submitted to the SFSB? 6. What are the roles of the Management, Compliance Officer and Internal Auditor in conducting Islamic investment business? 7. Must all Islamic financial products including Islamic securities be approved by the SAB and SFSB? Why? 8. What is a Syariah Governance Framework? 9. Company Halalan Tayyiban intends to change the Syariah concept of its existing Islamic investment product from Musharakah to Musharakah Muntanaqisah. What is Company Halalan Tayyiban required to do? 12 Additional Recommended Reading 1. Brunei Darussalam Central Bank (2013), Securities Markets Order, 2013, available at https://www.ambd.gov.bn/SiteAssets/Download/SMO2013.pdf 2. Brunei Darussalam Central Bank (2015), Securities Markets Regulations, 2014, available at https://www.bdcb.gov.bn/SiteAssets/Pages/Securities-Market-2015,-Compunding-Offenses- and-Fees/Securities%20Markets%20Regulations,%202014%20V2.pdf 3. Brunei Darussalam Central Bank (2017a), Guideline No. CMU/G-4/2017/4: Guideline on Application to Carry on Islamic Investment Business, 4. Brunei Darussalam Central Bank (2017b), Guideline No. CMU/G-5/2017/5: Guideline on Conducting Islamic Investment Business – Dealing and Arranging Deals in Investments 5. Brunei Darussalam Central Bank (2018), Guideline No. IFAU/G/1/2018: Guidelines On The Islamic Product Approval Process Under Section 14 Of The Syariah Financial Supervisory Board Order, 2006 6. Brunei Darussalam Central Bank (2018b), Guideline No. IFAU/G/2/2018: Guidelines On Syariah Governance Framework For Financial Institution In Brunei Darussalam 7. Brunei Darussalam Central Bank (2018c), Notice No. IFAU/N/1/2018: Notice To Financial Institutions On Syariah Governance Framework 8. Attorney General Chambers (2006), Syariah Financial Supervisory Board Order, 2006, available at http://www.agc.gov.bn/AGC%20Images/LOB/Order/MNOP/Syariah%20Financial%20Super visory%20Board%20Order,%202006.pdf 9. Yunus, S. bt M., al Haneef, S. S., Kamaruddin, Z., & Mahmud, M. W. (2017). Purification of Non-Halal Income in Malaysian Islamic Banks: An Overview (Penyucian Pendapatan Tidak- Halal Di Bank-Bank Islam Malaysia: Satu Tinjauan). Journal of Islam in Asia (E-ISSN 2289- 8077), 14(2), 305–326. https://doi.org/10.31436/jia.v14i2.616 13 Appendix 1 - Additional notes on Implementing an Internal Syariah Audit Framework Background (1) All Financial Institutions including capital market services firms and market operators shall establish an Internal Syariah Audit Framework (ISAF) within six (6) months from the effective date of the issuance of notice. (2) All Financial Institutions including capital market services firms, market operators are encouraged to adopt the recommendations set out in Guidelines on ISAF based on “comply” or “explain” basis. (3) The objectives of ISAF are as follows: a. To set out the expectations of the Authority on the Financial Institutions, including capital market services firms, market operators, and Banks to establish institutional arrangements and recommendations to facilitate the effective implementation of internal Syariah audit as an integral component of the SGF. b. To provide guidance for the Financial Institutions, including capital market services firms, market operators and Banks in specifying the scope of internal Syariah audit, internal Syariah audit objectives, internal Syariah audit governance, internal Syariah audit charter, competency of internal Syariah auditors, internal Syariah audit process and reporting for internal Syariah audit. c. To enhance the role of the BOD, the SAB and the Management of the Financial Institutions including capital market services firms, market operators and Banks in relation to Syariah financial matters. Requirements (1) All Financial Institutions including capital market services firms, market operators and Banks shall ensure that the Internal Syariah Audit Report is endorsed by the Financial Institution’s Audit Committee. A copy of the report shall be submitted to the BOD, SAB and the Management. (2) Every Financial Institution including capital market services firms, market operators and Banks shall submit the Internal Syariah Audit Report to the Authority within forty (14) 14  working days after the BOD meeting or such longer period may be permitted by the Authority. Source: Brunei Darussalam Central Bank (2018b), Guideline No. IFAU/G/2/2018: Guidelines On Syariah Governance Framework For Financial Institution In Brunei Darussalam Brunei Darussalam Central Bank (2018c), Notice No. IFAU/N/1/2018: Notice To Financial Institutions On Syariah Governance Framework 15