Keynote Presentation
YBhg Datin Zarinah Anwar
Deputy Chief Executive, Securities Commission
at the
Asian Islamic Banking & Finance Summit
21 – 22 September 2004
Mandarin Oriental Kuala Lumpur

Distinguished speakers,
Ladies and Gentlemen
Good morning.


First of all, I would like to thank Euromoney for inviting me to deliver a keynote presentation at this important event, the Asian Islamic Banking and Finance Summit. I am very pleased to share with you my views on a subject that is gaining considerable recognition globally.

Islamic Capital Markets

Islamic financial services and products are increasingly recognised as having the ability to become a viable option to the range of financial services and products available in international markets today. Enhanced efforts at development and promotion internationally have seen the establishment of the Dow Jones Islamic Market Index, the FTSE Global Islamic Index series and the like. This is a clear recognition of the tremendous potential of Islamic services and products by the global community.

Today, there are more than 200 Islamic financial institutions operating in 48 countries with combined assets in excess of US$200billion and an annual growth rate of 12-15%1 . The size of Islamic equity funds globally is approximately US$3.3 billion, with an annual growth rate of more than 25% over the past seven years, while the size of Islamic bonds globally is said to be US$25billion. Still, this represents a minute portion of the overall market. Thus the potential for the industry to grow is tremendous.

Malaysia has emerged as a significant player in this segment of the market. As at 30 June 2004, there are 65 Islamic unit trust funds in Malaysia, with total approved fund size of 31.2 billion units and net asset value of RM 5.4 billion constituting 7 percent of the net asset value of the unit trust industry. The size of the Islamic corporate bond market is RM64.3 billion or 36% of the total corporate bond market. In the equities market, 80% of Bursa Malaysia’s total listed stocks are classified as Syariah compliant stocks.

In the face of rapid expansion of this market segment, it is important that we spend some time taking stock of the current trends within the industry and deliberate on the necessary regulatory framework for Islamic finance that would achieve both the broad objectives of investor protection; fair, efficient and transparent markets; and reduction of systemic risk as well as compliance with Islamic principles as required by Syariah .

In my presentation today, I will discuss how market discipline through its components – disclosure, transparency and governance relates to Islamic Finance, specifically in the context of the Islamic Capital Market.

The Importance of Market Discipline

The recent wave of corporate failures around the world has renewed interest in market discipline in financial systems. The concept of market discipline incorporates two distinct components: the investor’s ability to evaluate a firm’s intrinsic value; and the responsiveness of management to investor feedback impounded in security prices or, alternatively, regulatory feedback triggered by changes in security prices. Markets value well capitalised and well-managed companies as much as regulators do; therefore they are capable of creating incentives for companies that manage their businesses in a sound and efficient manner, and disincentives for those that don’t.

Enhanced market discipline also paves the way for a more liberalised financial system and reduces the need for regulatory intervention. Since a level of discipline is provided by the market, through counterparty evaluation and monitoring, formal regulation by the authorities can be reduced. This will in effect reduce the overall cost of regulation and help promote greater efficiency in the financial market.

The Three Pillars Of Market Discipline – Disclosure, Transparency And Governance

Ladies and gentlemen

In order to ensure effective market discipline, it is necessary for markets to have access to timely, adequate and accurate information. The three pillars of market discipline – disclosure, transparency and governance – are the pre-requisites for an effective system of market discipline since they provide the key in guiding the decisions of shareholders, creditors and other stakeholders.


For disclosure to be effective, financial statements and reports must be contemporaneous, comprehensive and relevant. They must reveal the results of the stewardship and accountability for the management of resources. Sound auditing and accounting standards are therefore essential, and audit committees and external auditors must provide honest, independent judgement which will enable investors to make informed decisions.

Similarly, company managers must ensure that public disclosures clearly identify all significant risk exposures and their effect on the firm’s performance and potential. In the long run, disclosures will benefit well-managed companies by allowing them access to funds in the market at rates that reflect their sound management.


Disclosure however is not necessarily synonymous with transparency. Thus information disclosed must be provided in context – to provide market participants with the ability to accurately assess the firm’s performance, values and its risk profile. Transparency allows investors to make more informed decisions on how best to allocate their resources. Because capital is directed to its most productive uses, transparency will result in improved resource allocation and enhanced market efficiency.


Effective disclosure and transparency as tools of market discipline, are predicated on good governance. Following the major corporate failures of recent years, the process and quality of governance must be high on the agenda of directors of corporations. Good governance requires focus not only on compliance auditing and oversight, but also on performance of the corporation – i.e. is it doing the right things (investment initiatives) necessary to achieve its strategic objectives and are those initiatives being undertaken satisfactorily in order to ensure that wealth is created. The International Federation of Accountants Committee (IFAC) recently introduced the concept of enterprise governance which requires corporations to maintain focus both on conformance and performance to ensure that governance addresses adequately the issue of wealth creation. Investors in turn, must harness their efforts to exert influence on management to ensure appropriate corporate conduct, thus promoting transparency and shareholder value in the long term.

Promoting disclosure, transparency and governance through Disclosure-based regulation (DBR)

It is ironic but true that disclosure, transparency and governance, as tools of market discipline, must be facilitated by an appropriate regulatory framework, a framework that imposes certain standards of disclosure, penalises disclosure of false and misleading information and effectively puts the onus on the investors to make informed decisions about the merits of a particular investment based on the information available.

The guiding principle used in formulating such a disclosure-based framework in Malaysia was that there had to be sufficient and accurate disclosure of all relevant information pertaining to the company’s business, finances, prospects and terms of the securities to allow potential investors to make their own informed investment decisions. The focus would be on whether the applicable standards of disclosure were complied with, and whether sufficient due diligence had been performed on the information disclosed.

As a result of the shift to DBR, our regulatory framework demands enhanced standards of disclosure and governance which are backed by strong penalties. Companies and their advisors bear a heavier responsibility with regard to the accuracy and completeness of the information disclosed. Investors are also required to assume a higher level of responsibility in evaluating the risks of a particular offering based on the disclosed information before investing.

Regulatory framework for Islamic Capital Market

The point has to be made that the same regulatory framework applies across the board regardless of whether it is the conventional or the Islamic capital market (ICM) that is being regulated. ICM products should not be exempted from meeting the set requirements for disclosure, transparency and governance. Consequently, regulators often rely on a two-tier approach to regulate the provision of Islamic financial services and products in order to ensure that the goals and objectives of securities regulation are not compromised. These products and services must comply with both the general conventional requirements (ie the first tier) and specific requirements by virtue of being an Islamic service or product (ie the second tier)

The first tier

Thus, in Malaysia for example, pursuant to the first tier, all issuers of Islamic products are obliged to comply with disclosure requirements relating to prospectuses or trust deeds. Similarly, Islamic financial intermediaries are subject to the full range of requirements related to their activities, for example, disclosure of interests in the provision of investment advice and the segregation of client monies in trust accounts. Listed Islamic financial intermediaries are also subjected to the conventional capital market requirements and disclosure standards derived from statutes and the listing requirements.

The Islamic financial system is generally based on four tenets. These are:

  1. risk sharing – the terms of financial transactions need to reflect a symmetrical risk/return distribution for the respective participants in the transaction;
  2. materiality, in that it must relate to a real economic transaction;
  3. no exploitation – a financial transaction should not lead to the exploitation of any party to the transaction; and
  4. no financing of haram, that is, sinful activities for example, gambling.

Second tier

Thus ICM products and services are subjected to a second tier regulation, which essentially means that they have to comply with the Syariah .

In practice, where feasible, the additional requirement for Syariah compliance is added on to the existing first-tier regulations. For instance, the Unit Trust Guidelines apply generally to all unit trust funds but there is an additional section that must be complied with by Islamic unit trust funds. These additional requirements relate to, among other things, the appointment of a Syariah committee or adviser, specific reporting requirements, and the appointment of a designated compliance person.

When this is not feasible, modifications are made to the first-tier regulation. The regulation of Islamic corporate bonds is a case in point. “Debenture” is defined in section 2 of the Securities Commission Act in a manner that requires the element of indebtedness of a corporation, and this is reflected in the Private Debt Securities (PDS) Guidelines issued by the Securities Commission in 2000. Because all Islamic bonds were issued pursuant to these Guidelines, such issuance were restricted to those based on the principles of debt obligation such Bai ‘Bithaman Ajil. The Guidelines could not be used for the issuance of Islamic bonds like Musyarakah or Mudharabah which are based on some kind of equity ownership in the asset or business rather than a debt obligation. As a result of the definition in the first tier regulation, Islamic bond development was impeded.

To remedy this, the SC after extensive consultation with industry, de-coupled Islamic bonds from the definition of debentures and introduced a new term “Islamic Securities” to the SCA by way of a prescription order. New “Islamic Securities Guidelines” were also introduced, recognising that certain types of Islamic bonds will have features more akin to equity rather than debt products and that this would need to be subjected to additional disclosure requirements through the issuance of an information memorandum to prospective investors to cover relevant disclosures.

Ensuring Effective Disclosure without imposing undue Regulatory Cost

It is trite but true that for ICM products and services to be acceptable to all investors and issuers, it is absolutely vital that these products and services comply with the universally accepted principles of securities regulation – they must provide the same level of protection for investors, be offered within markets that are fair, efficient and transparent and must not be more susceptible to systemic risks than the conventional products. They must also be offered on terms, which are just as or more attractive and cost-effective than the conventional products in order to be competitive.

However as we know, ICM products have to conform to Syariah principles and that Muslims who subscribe to these products and services do so for these reasons. Regulators therefore have to ensure that these products and services are indeed true to label and that the trust in the system is safeguarded.

The adoption of the two-tier approach to regulation that I mentioned earlier is intended to have this effect. It must be pointed out though that this two-tier approach is not unique to the regulation of Islamic servies and products. Similar additional requirements are imposed on Ethical trust funds to ensure that the investors obtain what they purchase.

It is because of this additional tier of requirements that there could be additional costs involved. We recognise that the regulatory cost of prescriptive regulations of this nature may be more significant than mere disclosure requirements. However, it is felt that this is necessary for investor protection and market assurance given that Islamic finance is still in its early stages of development. The cost to the market in terms of loss of investor confidence and reputation will be far greater should products and services turn out to be not true to label. We are however confident that in time to come, the level of regulatory intervention will decrease as the market matures and is able to self-regulate.

The Correlation between Disclosure, Transparency and Governance in Islamic Finance

Market discipline applies across the markets in Malaysia irrespective of whether it is ‘conventional’ or the Islamic market. However, the components of market discipline, that is, governance, disclosure and transparency are even more pertinent in the context of the Islamic capital market. The risk sharing principle, which is based on Islamic concepts of partnership and profit sharing underscores the need for disclosure, transparency and governance. In carrying out any financial transaction, the Syariah requires parties to settle in advance the terms and conditions for redistribution of profits and for there to be proper record keeping2 . Subsequently, it is the practice for parties to make full disclosures of their value and risks so these contracts can be drawn in advance.

In addition, because of the Syariah precept that all wealth creation should result from a partnership between the investor and user of capital, the relationship between the parties is always based on trust. Thus, ICM participants are obliged to make known not only their positions and risks in a transparent manner but also how the money or property held in trust by them is managed.

The risk/reward element also means that the returns to capital must be tied to the profits generated from the capital rather than a pre-determined interest based. Subsequently, financial forecasts and year-end results would also have to be reported accurately and in timely fashion so that the profits can be calculated precisely and distributed fairly based on the capital infused and the contract terms agreed upon earlier.

Recognising that effective disclosure and transparency requires proper governance, in Malaysia for example, the SC also require that all bond and unit trust issuers consult and obtain confirmation from a Syariah advisor that their products are Syariah compliant. This helps to preserve the integrity of the market as any weakness or faultlines here would have the effect of undermining the confidence of the markets in the product and ICM as a whole.

However, it must be emphasized that the Syariah gatekeepers must rely on directors and managers of companies to provide them with the information necessary to enable them to make the requisite assessment. If Syariah advisers do not get accurate and comprehensive information from the companies concerned, then their assessment could be inaccurate. For example, in screening listed companies to ensure whether they can be classified as Syariah compliant stocks, the SC’s Syariah Advisory Council examines the financial reports as well as other information that they require from the companies. If these companies fail to disclose the requisite information or provides information that is misleading, the screening process becomes inaccurate. The need for directors and managers of companies to act honestly in providing full and accurate information cannot be overemphasized.

Addressing the remaining challenges

Although Islamic finance is growing rapidly, it is nonetheless still undergoing substantial development and innovation; thus challenges remain significant. In the context of the subject matter of my presentation today, the issue of accounting standards and integrated supervision are two areas requiring attention.

Accounting Standards

One of the key tenets to enhancing the overall quality of standards in Islamic Finance is to ensure the applicability of internationally acceptable and high quality accounting standards. Application of accounting standards and practices in Islamic Finance currently are not uniform, with some countries applying international accounting standards issued by the International Accounting Standards Board (IASB) whilst some others have chosen to adopt Islamic standards issued by the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI). Some other jurisdictions are formulating their own national Islamic accounting standards.

The challenge is to develop a globally acceptable and high quality financial reporting framework for Islamic financial services that will reflect the characteristics of Islamic finance and yet ensure that investors and users of financial statements have access to information of the same level of reliability and quality that they are demanding in the conventional markets. Achieving this objective would go a long way in enhancing the profile and acceptability of Islamic products globally.

Integrated supervision and regulation for Syariah

On the issue of integrated supervision, whilst the Islamic financial market has been a growing niche within the modern financial sector, its growth has not been accompanied by the emergence of a coherent body of governing rules and regulations intrinsic to the Islamic perspective. The development of Islamic finance and regulators of Islamic financial markets would certainly benefit from an integrated supervision and regulation of the unique risks associated with Islamic financial products.

The establishment of the Islamic Financial Services Board (IFSB) in 2002 is certainly an important initiative that can contribute towards achieving this objective. IFSB, I understand, is currently developing international prudential and supervisory standards and best practices for Islamic financial institutions.

Similarly, recognising the growing importance of Islamic capital markets, and the need to address regulatory issues and challenges, the International Organisaton for Securities Commissions (IOSCO) established a taskforce on Islamic Capital Markets, chaired by Malaysia. The taskforce has recently released a report on the state of development and regulation of the Islamic capital market globally.

The task force found that the Islamic Capital market constitutes a segment of the wider securities market and that the conventional securities regulation framework and principles apply equally to the Islamic Capital Market with the addition of some form of Syariah approval or certification process. This finding is significant as it postulates that Islamic Capital market products and services may be introduced and developed within any existing well-structured securities market.

The challenge is not only to ensure greater uniformity in regulation and practices to achieve a satisfactory level of protection for investors but also to ensure that these rules accommodate the need for compatibility and acceptability within the international regulatory framework.


Ladies and gentlemen, there are vast opportunities to be tapped globally for Islamic finance, not just amongst the Muslim investor community, but all in the global financial market. High standards of disclosure, transparency and governance will ensure sufficient levels of investor confidence that will lead to the development of a market that is robust and credible. Indeed the major challenge in the development of Islamic finance is the need for it to be integrated within the global architecture. Thus the twin approach of ensuring compliance with the Syariah, and with internationally acceptable standards of conduct and discipline are key to success.

Thank you for your attention.

1 World Bank Policy Research Working Paper 3327, March 2004: Dahlia el Hawary, Wafik Grais and Zamir Iqbal : Regulating Islamic Financial Institutions: The Nature of the Regulated.

2Verses 282-3 Surah Al Baqarah of the Holy Quran