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Malaysia’s New Financial Services Architecture

By Paul P Subramaniam
Posted: 4th April 2013 09:57
Introduction
 
The Malaysian financial sector is poise to experience major changes in the way financial institutions operate when the Islamic Financial Services Act 2013 (“IFSA”) and the Financial Services Act 2013 (“FSA”) come into force on their appointed date which is expected to be sometime soon.
 
This write-up will focus only on some of the salient changes brought about by the FSA, and its effects on the non-Islamic financial services sector of Malaysia.
 
The FSA is a consolidation of four Acts of Parliament, now repealed (the Banking and Financial Institutions Act 1989, Payment Systems Act 2003, Insurance Act 1996 and the Exchange Control Act 1953).
 
The new Acts, modelled after the Basel Core Principles for Effective Banking Supervision architecture a new set of dynamics for the financial services in Malaysia focussed at a greater level of transparency, accountability and governance in the management and operation of both conventional and Islamic banking in Malaysia. The FSA will also see a greater role by the Central Bank of Malaysian (Bank Negara Malaysia [“the Bank”]) in terms of regulating and supervising financial institutions, payment systems, and other relevant entities including the oversight of the money market and foreign exchange market to promote financial stability and compliance with the Shariah.
 
Financial Services Act 2013 (FSA)
 
The FSA regulates non-Islamic or conventional financial goods and service providers. Among others, directly affected by the provisions of this new Act are conventional banks, investment banks, insurance companies, payment systems operators and financial holding companies. The Act would undoubtedly impact businesses and the way they conduct themselves due to the following implications of the Acts:
 
  • Stricter requirements vis-à-vis consumer protection
  • Imposition of standards of business conduct on financial institutions etc.
  • Stricter rules on shareholding
  • New and wider powers of intervention for the Bank
  • Greater overall corporate governance requirements on individuals and institutions
 
Some of the salient provisions of FSA to effect the above changes, are:
 
  • Imposition of prudential requirements
  • Codification of directors’ duties
  • New criteria vis-à-vis shareholder suitability and entitlement to shareholding
  • Expanded reporting obligations for auditors
  • Consumer Protection & Proper Business Conduct
  • New and wider powers of intervention for the Central Bank
 
Prudential Requirements
Under the previous regime governed by the Banking and Financial Institutions Act 1989 (“BAFIA”), prudential requirements referred only to the maintenance of net assets depending on the nature and scale of the institution’s operations, the interests of the depositors or potential depositors, and the risks inherent in those operations, and in the operations of any other related corporation of the institution. This is now governed by Section 12 of the FSA (Requirements on minimum capital funds or surplus of assets over liabilities).
 
The FSA regime on the other hand constitute a step-jump in regulation for the Malaysian financial system. In line with the Financial Sector Blueprint 2011 and new international standards as a result of global financial crisis, the Bank now has power to dictate what is appropriate for an institution in respect of its:
 
  • Capital adequacy
  • Liquidity
  • Corporate governance
  • Risk management
  • Related party transactions
  • Maintenance of reserve funds
  • Insurance funds
  • Prevention of an institution from being used, intentionally or unintentionally for criminal activities.
 
The Bank also has the power to dictate standards which relate specifically to capital market products or capital market services (jointly with the Securities Commission of Malaysia).
 
The FSA requires institutions to ensure that its internal policies and procedures reflect the Bank’s standards on prudential requirements. Where no standard is set by the Bank, the institution is expected to manage its business, affairs, and activities in a manner consistent with sound risk management and governance practices which are effective, accountable and transparent.
 
The FSA expressly requires EVERY director and officer of an institution at all times to comply with such internal policies and procedures adopted. These standards will be set by the Bank in time. 
 
Directors Duties
 
No person may be appointed as a director (or senior officer) of a licensed person without the approval of the Bank (taking into consideration the FSA’s newly expanded ‘fit and proper’ test). The Bank may decide where such requirements have been violated and may remove directors for failing to comply with the fit and proper test at any time.
 
The FSA requires the board of directors to have regard to the interests of depositors and policy holders over and above the interests of shareholders.
 
Directors, controllers, officers, partners and management of a licensed person may be deemed liable for any offence committed by the licensed person, where the only defence available is that the offence was committed without consent AND that due diligence was exercised to prevent its commission. Delegation to or reliance on 3rd parties is irrelevant.
In addition, the FSA requires directors to disclose interests in material transactions or material arrangements to their fellow board members. The Bank may specify what constitutes a material transaction or material arrangement.
 
Section 56 of the FSA dictates that the board of directors shall;
 
  • Set out and oversee the implementation of business and risk objectives and strategies and in doing have regard to the long term viability of the institution and reasonable standards of fair dealing;
  • Ensure and oversee the effective design and implementation of sound internal controls, compliance and risk management systems commensurate with the nature, scale and complexity of the business and structure of the institution;
  • Oversee the performance of the senior management in managing the business and affairs of the institution; and
  • Promote timely and effective communications between the institution and the Bank on matters affecting or that may affect the safety and soundness of the institution.
 
Directors duties complement and do not derogate from the duties of directors under the Malaysian Companies Act 1965.
 
Shareholder’s Suitability and Investor’s Entitlement to Shareholding
 
The FSA provides transparent factors for the Bank’s consideration when assessing shareholder’s suitability which include;
 
  • Character and integrity of the applicant, or its reputation for being operated in a manner that is consistent with standards of good governance and integrity (if the applicant is a body corporate)
  • Soundness and feasibility of the plans of the applicant for the future conduct and development of the business of the licensed person
  • Nature and sufficiency of the financial resources of the applicant as a source of continuing financial support to the licensed person
  • Business record and experience of the applicant
  • Whether the nature, scale, and activities of the corporate group of the applicant will impede the effective regulation and supervision of the licensed person
  • Whether the application will be in the best interests of Malaysia, having regard to;
 - The effect of the investment on the level and nature of economic activity in Malaysia;
 
 - The contribution towards enhancing international trade and investment linkages between Malaysia and other countries;
 
 - The effect of the investment on the stability of the financial system including on the conduct and behaviours that could pose a risk to the financial system; or
 
 - The degree and significance of participation of Malaysians in the financial sector.
 
Additionally, the FSA stipulates that no investor is allowed to hold more than 10% of an institution’s shares. Where a transaction results in a holding of more than 5% of the institution’s shares, the Bank’s approval is required. Approval is also required where an investor acquires a material interest in a corporation (the Bank may specify what constitutes material interests).
 
Thresholds for approval of shareholding changes;
 
  • Approval required where acquisition results in an aggregate holding of interest in shares equal to or exceeding multiples of 5%
  • Approval required where any person gains control of a licensed institution
  • Approval required where disposal of shares results in an aggregate holding of shares below 50% or if such disposal results in change in control of the licensed institution.
Auditors
 
Under the FSA, auditors are now statutorily bound to report to the Bank in the event that;
·         There has been a non-compliance of any standards which may have a material effect on the financial position of the institution
 
  • There is any weakness in the internal controls which is relevant to the financial reporting process undertaken by the institution
  • The financial position of the institution is likely to be or has been materially affected by any event, conduct of activity by the institution or any weakness in the internal controls of the institution
 
Consumer Protection & Proper Business Conduct
 
The FSA grants the Bank authority to undertake various actions to ensure that financial services providers are fair, responsible and professional when dealing with financial customers.
The Bank may specify standards on;
 
  • Transparency and disclosure requirements
  • Fairness of terms in a contract for financial services/products
  • Promotion of financial services or products
  • Provision of recommendations or advice
  • Complaints and dispute resolution mechanism
·          
The FSA also specifies prohibited business conduct (Schedule 7 of the FSA) where contravention may result in imprisonment not exceeding 5 years and or a fine of no more than RM 10 million, or to both.
Institutions are expressly prohibited from exerting undue influence and pressure on consumers to make debt repayments and to accept unsolicited offers for financial products and services.
 
The FSA also prohibits the following;
 
  • Engaging in conduct that is misleading or deceptive in relation to the nature, features, terms or price of financial services or products
  • Inducing financial consumers to do an act or omit to do an act in relation to financial services or products by
 - Making misleading, false or deceptive statements
 - Dishonestly concealing or omitting material facts
 - Recklessly making any statement, illustration, promise, forecast or comparison which is misleading, false or deceptive
 
  • Exerting undue pressure, influence or using or threatening to use harassment, coercion, or physical force in relation to the provision of or payment for financial services or products
  • Demanding payments for unsolicited financial services or products unless the financial consumer has communicated his acceptance of the offer either orally or in writing
  •  Exerting undue pressure on, or coercing, financial consumers to acquire financial services or products as a condition for acquiring another financial service or product
  • Colluding to fix or control the features or terms of financial services or products to the detriment of financial consumers, except for tariff or premium rates or policy terms approved by the Bank.
 
Powers of the Bank
 
Under the new regime, the Bank is endowed with wide powers to intervene in ensuring sound risk management and good governance policies.The Bank’s powers are broad, including the ability to restrict the institution from carrying on with a business arm and dispose of investments and assets if it deems necessary.
 
Through the Bank’s ability to vet directors and senior officers, the Bank may intervene in an institution’s operations. This intervention even extends to the shareholders of institutions as the Bank now has the power to order share transfers or share issues to take place.
 
Summary of powers of the Bank under the FSA;
 
  • Power to remove directors, CEOs, senior officers, etc
  • Assumption of control in certain circumstances (see Section 177)
  • Power to appoint a receiver and manager
  • Power to reduce share capital of institutions
  • Power to provide liquidity or financial assistance to institutions
  • Power to apply for winding up of institutions
·          
Section 234 of the FSA empowers the Bank to take action against individuals and corporations, where any failure to comply with provisions of the Act, directions, regulations, etc. will result in administrative action.
 
Furthermore, the Bank has power to prescribe monetary penalties, as well as take action on behalf of any individual or corporation.
 
Imprisonment is only available for individuals, and the FSA provides forstrict liability offences. Offenders will be deemed to have committed the offence until proven that the offence was committed without his consent and he had exercised diligence to prevent its commission. Now, individuals liable for imprisonment are not restricted to senior management, but extends to anyone who forms part of the decision making process.
 
An offence committed by the institution is deemed to be committed by its;
 
  • Directors;
  • Officers; and 
  • Anyone concerned with planning, coordinating, directing or decision making
Conclusion
 
The new Act will undoubtedly have a profound impact on the way financial services players operate under this new architecture. We see the FSA as imposing greater requirements on financial services providers; holding companies will be required to relook at their structures; Board of Directors must now demonstrate greater involvement in implementing defensive policies and programmes to ensure compliance with the FSA’s newly imposed requirements; marketing strategies and agreements would have to be re-evaluated; and more active control and supervision by the Bank needs to be anticipated. 
 
Paul P Subramaniam is the Knowledge Management & Training Partner at Zaid Ibrahim & Co., Prior to that, he practiced as a litigation lawyer for 22 years, being involved in several significant cases. Paul now keeps the lawyers and partners updated as to changes in the law and industry which would impact our clients. He also serves as editor of our publications to our clients. In addition, Paul manages a Knowledge Database and also a Precedent Bank, to ensure best practices are undertaken in the firm.
 
Paul can be contacted via email at paul.p.subramaniam@zicolaw.com and via phone at +603 20879857

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