1.

What is the Shariah Advisory Council (SAC) of the SC and its role?

The SAC of the SC is a committee established by the SC in 1996 under section 18 of the Securities Commission Act 1993 (SCA). The SAC was given the mandate to ensure that the running of the Islamic capital market (ICM) complies with Shariah principles. Its scope of jurisdiction is to advise the SC on all matters related to the comprehensive development of the ICM, and functions as a reference centre for ICM-related issues. The members of the SAC consist of Islamic scholars/jurists and Islamic finance experts.

2.

What are the basic sources of research used in the ICM?

There are two basic sources of research used in the ICM:

3.

What is the list of Shariah-compliant securities?

The list of Shariah-compliant securities identifies Bursa Malaysia-listed companies whose activities conform to the Shariah criteria established by the SAC.

4.

How often is the list of Shariah-compliant securities updated?

The list is updated twice a year and released on the last Friday of May and November.

5.

What are the Shariah criteria adopted in evaluating the companies?

The involvement or uninvolment of companies in the following elements are criteria used for evaluating the status of Shariah-compliant securities:

• Financial services based on riba (interest);

• Gambling;

• Manufacture or sale of non-halal products or related products;

• Conventional insurance;

• Entertainment activities that are non-permissible according to Shariah;

• Manufacture or sale of tobacco-based products or related products;

• Stockbroking or share trading in Shariah non-compliant securities; and

• Other activities deemed non-permissible according to Shariah.

The SAC also takes into account the level of contribution of interest income received by the company from conventional fixed deposits or other interest-bearing financial instruments. Dividends received from investments in Shariah non-compliant securities are also considered in the analysis carried out by the SAC.

For companies with activities comprising both permissible and non-permissible elements, the SAC considers two additional criteria:

• The public perception or image of the company must be good; and

• The core activities of the company are important and considered maslahah (public interest) to the Muslim ummah (nation) and the country, and the non-permissible element is very small and involves matters such as `umum balwa (common plight and difficult to avoid), `uruf (custom) and the rights of the non-Muslim community which are accepted by Islam.

6.

What are the benchmarks applied to determine the tolerable level of mixed contributions from permissible and non-permissible activities?

To determine the tolerable level of mixed contributions from permissible and non-permissible activities for turnover and profit-before-tax of a company, the SAC has established several benchmarks based on ijtihad (reasoning from the source of Shariah by qualified Shariah scholars). If the contributions from non-permissible activities exceed the benchmark, the securities of the company will be classified as Shariah non-compliant. The benchmarks are:

7.

What is the SAC's advice to investors who invest in Shariah-compliant securities, whose status is subsequently changed to non-compliant?

If at the time the announcement is made, the value of the securities held exceeds the original investment cost, such non-compliant securities must be liquidated. Any capital gains arising from the disposal of the non-compliant securities made at the time of the announcement can be kept by the investors. However, any excess capital gains made from the disposal after the announcement day at a market price that is higher than the closing price on the announcement day should be channelled to charities.

On the other hand, investors are allowed to hold non-compliant securities if the market price of the said securities is below the original investment cost. It is also permissible for investors to keep dividends received during the holding period until such time when the total amount of dividends received and the market value of the non-compliant securities held equal the original investment cost. At this stage, they are advised to dispose of their holding.

8.

What is the original investment cost?

The original investment cost is that incurred in acquiring securities, including brokerage or related transaction costs.

9.

What should investors do if they are offered rights issues, bonus issues, special issues or warrants of non-compliant securities which they hold?

Investors are allowed to subscribe to -

• any issue of new securities by a company whose non-compliant securities are held by investors, for example rights issues, bonus issues, special issues and warrants (excluding securities whose nature is non-compliant e.g. ICULS); and

• securities of other companies offered by the company whose non-compliant securities are held by investors.

10.

What should investors do if they invest in non-compliant securities?

The SAC advises investors to dispose of any non-compliant securities within a month of knowing the status of the securities. Any profit made in the form of capital gains or dividends received during or after the disposal of the securities are to be channelled to charities. The investor should only receive the original investment cost.

11.

Can non-Muslims trade in Shariah-compliant securities?

Investing in Shariah-compliant securities is not limited only to Muslims as the Shariah-compliant securities are part of the securities listed on Bursa Malaysia.

12.

What is the Kuala Lumpur Shariah Index (KLSI)?

The KLSI was launched on 17 April 1999 to meet the demands from local and foreign investors who seek to invest in securities which are consistent with Shariah principles. It acts as a benchmark for tracking the performance of Shariah-compliant securities and making better informed decisions.

13.

Apart from the list of Shariah-compliant securities, what other instruments are approved by the SAC?

Since the establishment of the SAC, several capital market instruments have been evaluated and approved:

• Ordinary shares;

• Warrants/TSR;

• Call warrants;

• Non-cumulative preference shares;

• Redeemable preference shares;

• Crude palm oil futures contracts;

• Crude palm kernel oil futures contracts;

• Khazanah zero-coupon bonds;

• Single Stock Futures (if the underlying is Shariah compliant); and

• Islamic asset securitisation/Islamic debt securitisation.

• Futures Contract Index

14.

Are there any Islamic stockbroking services available in the industry?

Yes. The Islamic stockbroking services provide the necessary link for Muslims to trade and invest in the stock market. It began in 1994 with the setting up of BIMB Securities Sdn Bhd, a full-fledged Islamic stockbroking company. Oher conventional stockbrokers have started to show their interest in Islamic stockbroking services.

15.

What are Islamic unit trust schemes?

The Islamic unit trust schemes are collective investment funds which offer investors the opportunity to invest in a diversified portfolio of Shariah-compliant securities which are managed by professional managers in accordance with the Shariah. The Islamic unit trust schemes are required to appoint a Shariah committee or Shariah adviser as stipulated in paragraph 6.04 of Guidelines on Unit Trust Funds to ensure that their operations are in accordance with Shariah principles. The schemes are available in many forms such as Islamic equity funds, Islamic bond funds, Islamic index funds and others.

16.

What are the requirements to appoint a Shariah committee and Shariah adviser for Islamic unit trust schemes?

The Shariah committee and Shariah adviser for Islamic unit trust schemes must be approved by the SC, satisfying the criteria stipulated in paragraph 6.05 of the Guidelines on Unit Trust Funds.

Where a Shariah committee is appointed, the committee must consist of at least three members who are individuals, be independent of the management company and be registered with the SC. In the case of a Shariah adviser (company), the company must have in its employment, a minimum of one full-time officer designated to be responsible for Shariah matters relating to the funds.

For approval from the SC, write to:

Head
Islamic Capital Market Department
Securities Commission
3 Persiaran Bukit Kiara
Bukit Kiara
50490 Kuala Lumpur.

17.

How are bonds structured in accordance with Shariah principles and how are they different from conventional bonds?

The sukuk are structured based on the specific contract of exchange of Shariah-compliant assets. Such contracts can be made through the sale and purchase of an asset based on deferred payment, leasing of specific assets or participation in joint-venture businesses. Hence, the issuance of sukuk is not an exchange of paper for money with the imposition of an interest but rather an exchange of Shariah-compliant asset for some financial consideration applying various Shariah principles, such as bai' bithaman ajil (BBA), murabahah, ijarah, mudharabah and musyarakah that allow the investors to earn profits from the transactions.

18.

Who would confirm and verify that the bonds are structured in accordance with Shariah principles?

The issuance of sukuk is regulated by the SC through the framework provided under the Guidelines on the Offering of Islamic Securities (Guidelines). The structure of sukuk must be confirmed and approved by a Shariah adviser who is appointed by the issuer. A Shariah adviser can be an independent Shariah adviser approved by the SC or a Shariah committee attached to a financial institution that operates Islamic banking activities approved by the Central Bank.

19.

What are the Shariah principles that can be applied in structuring sukuk?

Sukuk can be structured by applying various Shariah principles and concepts that are listed in Appendix 1 of the Guidelines. They have been endorsed by the SAC as appropriate for structuring sukuk. Prior consultation with the SAC is needed if the Shariah principle or concept applied by the issuer is not among those stated in Appendix 1 of the Guidelines. Prior consultation is also encouraged for any principle or concept stated in Appendix 1 which has no market precedence.

20.

Who can become an independent Shariah adviser for sukuk and what are the requirements?

Approval by the SC for an independent Shariah adviser for sukuk is based on satisfying the criteria stipulated in paragraph 6.01 of the Guidelines. For companies, the criteria stipulated in paragraph 6.02 must also be satisfied. For approval, write to:

Head
Islamic Capital Market Department
Securities Commission
3 Persiaran Bukit Kiara
Bukit Kiara
50490 Kuala Lumpur.

21.

SAC's decisions in relation to sukuk

(a) Debt trading (bai` dayn)
The SAC has agreed to accept the principle of bai`dayn i.e. debt trading as one of the concepts for developing Islamic capital market instruments. This was based on the views of some of the Islamic jurists who allowed this concept subject to certain conditions. In the context of the capital market, these conditions can be met when there is a transparent regulatory system to safeguard the maslahah (public interest) of the market participants.

(b) Islamic benchmark sukuk
The Islamic benchmark bond, also known as the Khazanah Bond, is Shariah compliant. This bond is structured based on murabahah principles.
(c) Mudharabah sukuk by securitising Islamic hire purchase

The SAC has approved the concept and mechanism applied in issuing sukuk based on the mudharabah principle through securitisation of Islamic hire purchase. The purchasing of Islamic hire purchase is based on the Shariah concept of debt trading (bai`dayn).

(d) Ittifaq dhimni principle
The SAC has approved the ittifaq dhimni principle in structuring sukuk. Ittifaq dhimni refers to an understanding that exists before a contract is sealed. The seller and buyer have made a prior agreement to sell the asset at a certain price and to buy back at a certain price. In this context the principal dealer will buy the assets after he has succeeded in securing the tender. This refers to the understanding in a sale and purchase transaction, in accordance with bai` muzayadah trading. It is likely that in the context of the formation of an Islamic benchmark sukuk, there is more than one principal dealer successfully buying the assets. Therefore, several principal dealers will be partners in buying the assets according to their allotments.

(e) Dha` wa ta'ajjal

The SAC has agreed to accept the use of the dha` wa ta'ajjal concept in promoting Islamic capital market instruments. Dha` wa ta'ajjal is the action of a creditor forfeiting part of the debt when the debtor settles the balance of his debt earlier. (f) Third-party guarantee on the capital

Sukuk issuers are allowed to apply third-party guarantee on the capital invested under the principles of mudharabah/musyarakah. It was agreed that a fee (ujrah) is allowed to be paid to the guarantor on the condition that the guarantee should not be on a recourse basis, which means the investors cannot go after the issuers in the event of business failure since the guarantee will be provided by the guarantor. The investors are also allowed to ask for collaterals from the issuers in view of possible gross negligence by the issuers.

(g) Government award (iqta')
All contracts awarded by the government i.e. concession, construction, supply and service contracts are accepted as approved underlying assets for structuring sukuk. The same principle can also be applied to contracts awarded by state governments, government agencies and government-related companies. The decision was made based on the principle of government award (iqta').

(h) Compensation and rebate
Sukuk investors are allowed to impose a compensation (ta'widh) on late and default payment by the issuers for contract exchange (uqud muawadhat) transactions only. Ta'widh can be imposed after it is found that mumathil (deliberate delay in payment) is present on the part of the issuer to settle payment of the principal or profit. The rate of ta'widh on late payment of profit is 1% per annum of the arrears and it cannot be compounded. While the ta'widh rate on failure to settle the payment of the principal is based on the current market rate in the Islamic interbank money market, it too cannot be compounded.

In addition, upon request by the issuers of sukuk for an early settlement, a rebate (ibra') is allowed to be given to investors.

(i) Rebate (ibra')
The SAC has resolved that the ibra' (rebate) clause for an early settlement can be inserted in the primary legal document of a sukuk transaction. The resolution is provided on the basis of `uruf (custom), maslahah (public interest) principles and to avoid gharar (uncertainty). The ibra' clause in the primary legal document is considered as syart (condition) that is complied with muqtadha al-`aqd (purpose of contract). However, the SAC has advised that the ibra' clause is to be separated from the pricing section in the primary document, whereby, the ibra' clause can be inserted in the payment and settlement section.

(j) "When Issue" (WI)
The "When Issue" (WI) process for the issuance of sukuk in the primary market is recognised as Shariah compliant. The ruling is made on the basis that there are no elements of riba (usury) and gharar (uncertainty) in the WI process.

(k) Asset pricing
The SAC has issued the guidelines on asset pricing in sukuk to facilitate the process of determining the purchase price of the asset used as an underlying asset for sukuk which are structured under the principles of ijarah, bai` bithaman ajil, bai` `inah and murabahah.

The SAC has resolved that the purchase price of the asset, if it is sold at a premium, should not exceed 1.33 times (one and one-third) of the market value. On the other hand, if the asset is sold at a discount, the purchase price should not be less than 0.67 (two-thirds) times of the market value.

To further facilitate the asset pricing process, the SAC has resolved that if the market value cannot be identified, hence fair value or any other suitable value can be used as long as it based on willing buyer-willing seller and be evaluated using appropriate valuation methods.

(l) Islamic asset securitisation
The SAC has resolved that asset securitisation is permissible if the underlying asset to the instrument is Shariah compliant. However, an asset which is in the form of debt structure such as murabahah and bai' bithaman ajil receivables cannot be securitised for the purpose of issuing Islamic asset-backed securities structured along the debt principles of murabahah and bai' bithaman ajil respectively.

(m) Conventional leasing receivables not to be used as underlying asset of sukuk
Sukuk issuers should use receivables derived from Islamic transactions, such as receivables from ijarah transactions as underlying assets. The ruling was made to further promote the development of Islamic instruments, such as those based on the ijarah principle.

(n) Floating-rate mechanism
The SAC resolved that a floating-rate mechanism can be applied for sukuk based on bai` bithaman ajil, murabahah and istisna'. This is made possible with the application of the rebate (ibra') element in determining the effective profit rate of sukuk. The effective profit rate is benchmarked against market rate movements.

(o) Issue of uncertainty on the possession of goods (ghair mustaqir) under purchase order (istisna') principles in sukuk structure
Istisna' transactions in Islamic bond structures are normally backed and supported by legal processes and clauses to protect the parties involved in the transactions. This is further supported by relevant legal and regulatory frameworks provided by the authorities. As such, elements related to ghair mustaqir or uncertainties are eliminated. In addition, the features of the istisna' principle are different as compared to those of advance purchase (salam) principle. The element of ghair mustaqir is usually related to the salam principle only.

22.

SAC's decisions in relation to Islamic unit trust funds

(a) Capital guaranteed funds
The concept and structure of conventional capital guaranteed funds can be adopted for Shariah-based capital guaranteed funds. This includes the application of a third-party guarantee and guarantor fee. Notwithstanding this, a Shariah-based capital guaranteed fund must comply with other Shariah requirements, including investments in Shariah-compliant instruments.

(b) Investments in non-compliant securities by Islamic unit trust funds
If Islamic unit trust funds invest in non-compliant securities due to contravention of the trust deeds by unit trust managers, any losses incurred should be borne by the unit trust managers and should not be charged to the funds as it is unfair for the investors/unit holders to bear such losses.