Malaysia CR1353

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January 28, 2013
January 29, 2001

February 2013
IMF Country Report No. 13/53
January 29, 2001 January 29, 2001
January 29, 2001

Malaysia: Report on the Observance of Standards and Codes
This Report on the Observance of Standards and Codes in Malaysia was prepared by staff of the
International Monetary Fund and the World Bank. It is based on the information available following
discussions that ended on September 7, 2012, with the officials of Malaysia. Based on the information
available at the time of these discussions, the report was completed in January 2013. The views
expressed in this document are those of the staff team and do not necessarily reflect the views of the
government of Malaysia or the Executive Board of the IMF.
The policy of publication of staff reports and other documents by the IMF allows for the deletion of
market-sensitive information.
Copies of this report are available to the public from
International Monetary Fund  Publication Services
700 19th Street, N.W.  Washington, D.C. 20431
Telephone: (202) 623-7430  Telefax: (202) 623-7201
E-mail: publications@imf.org Internet: http://www.imf.org

International Monetary Fund
Washington, D.C.

FINANCIAL SECTOR ASSESSMENT PROGRAM

MALAYSIA
REPORT ON THE OBSERVANCE
OF STANDARDS AND CODES
(ROSCS)
JANUARY 2013

INTERNATIONAL MONETARY FUND
MONETARY AND CAPITAL MARKETS DEPARTMENT

THE WORLD BANK
FINANCIAL AND PRIVATE SECTOR DEVELOPMENT
VICE PRESIDENCY
EAST ASIA AND PACIFIC REGION VICE PRESIDENCY

2
Contents

Page

Glossary .....................................................................................................................................4
I. Basel Core Principles For Effective Banking Supervision .....................................................6
A. Summary ...................................................................................................................6
B. Institutional Setting and Market Structure Overview ...............................................7
C. Preconditions for Effective Banking Supervision .....................................................7
D. Main Findings .........................................................................................................10
E. Key Findings and Recommended Action Plan ........................................................20
F. Authorities’ Response to the Assessment ................................................................22
II. Assessment of Insurance Core Principles (ICPs) ................................................................24
A. Summary, Key Findings, and Recommendations ...................................................24
B. Introduction and Scope............................................................................................24
C. Overview: Institutional and Macro Prudential Setting ............................................25
D. Preconditions for Effective Insurance Supervision .................................................28
E. Key Findings and Recommendations ......................................................................29
F. Authorities’ Response to the Assessment ................................................................38
III. IOSCO Objectives and Principles of Securities Regulation ..............................................39
A. Summary, Key Findings, and Recommendations ...................................................39
B. Institutional and Market Structure—Overview .......................................................39
C. Preconditions for Effective Securities Regulation ..................................................41
D. Main Findings .........................................................................................................42
E. Summary Implementation and Recommended Action Plan ...................................51
F. Authorities’ Response to the Assessment ................................................................53
IV. Core Principles for Effective Deposit Insurance Systems (IADI) .....................................56
A. Methodology Used for the Assessment ..................................................................56
B. General Preconditions for an Effective Deposit Insurance System ........................56
C. Well-Developed Legal Framework .........................................................................57
D. Sound Accounting and Disclosure Regime ............................................................58
E. Main Findings ..........................................................................................................59
F. Malaysia’s Islamic Deposit Insurance System ........................................................60
G. Summary of Compliance and Recommended Actions ...........................................61
V. Summary Assessment of Observance of the CPSS-IOSCO Principles for Financial Market
Infrastructures ..........................................................................................................................65
A. Introduction .............................................................................................................65
B. Institutional and Market Structure...........................................................................65
C. Payments System and Bond Clearing and CSD ......................................................66
D. Securities Clearing and CCP ...................................................................................67
E. Central Securities Depository ..................................................................................68
F. Key Recommendations for FMIs.............................................................................69
G. Authorities’ Response to the Assessment ...............................................................73

3
Tables
1. Summary Compliance with the Basel Core Principles—Detailed Assessments .................14
2. Recommended Action Plan to Improve Compliance with the Basel Core Principles .........20
3. Summary Implementation of the ICPs .................................................................................29
4. Recommendations to Improve Observance of the ICPs ......................................................35
5. Summary Implementation of the IOSCO Principles—Detailed Assessments ....................45
6. Recommended Action Plan to Improve Implementation of the IOSCO Principles ............51
7. Summary of Compliance with the Deposit Insurance Core Principles................................61
8. Recommended Action Plan—Deposit Insurance Core Principles .......................................64
9. FMI Recommendations—RENTAS (RTGS, CSD and SSS) ..............................................69
10. FMI Recommendations—BMDC ......................................................................................70
11. FMI Recommendations—BMSC ......................................................................................71
12. FMI Recommendations—BMDepo ...................................................................................72
13. FMI Recommendations—Authorities................................................................................73
Figures
1. Insurance Sector: Composition of Assets ............................................................................26
2. Insurance Sector: Component of Market Risk Exposures ...................................................26
Boxes
1. Islamic Banking in Malaysia .................................................................................................8

4
GLOSSARY
AML/CFT
BAFIA
BCBS
BCPs
BFF
BM
BMD
BMDC
BMDepo
BMS
BNM
CAR
CBA
CCP
GDG
CGF
CME
CMSA
CPs
CPSS
CSD
DIS
DFI
DPS
DVP
FHC
FMI
FRS
FSA
FSAP
FSEC
FSPSR
IBA
ICAAP
IDIF
IFRS
IOSCO
IRB
LFSA
MASB

Anti-Money Laundering/Counter Financing of Terrorism
Banking and Financial Institutions Act 1989
Basel Committee on Banking Supervision
Basel Core Principles
Bridge Financing Facility
Bursa Malaysia
Bursa Malaysia Derivative Berhad (the derivatives exchange)
Bursa Malaysia Derivative Clearing
Bursa Malaysia Depository Sdn Bhd (the central depository)
Bursa Malaysia Securities Berhad (the stock exchange)
Bank Negara Malaysia
Capital Adequacy Ratio
Central Bank of Malaysia Act 2009
Central Counterparty
Government Deposit Guarantee
Clearing Guarantee Fund
Chicago Mercantile Exchange
Capital Markets and Services Act 2007
Core Principles
Committee on Payment and Settlement Systems
Central Securities Depository
Deposit Insurance Scheme
Development Finance Institution
Differential Premium System
Delivery versus Payment
Financial Holding Company
Financial Markets Infrastructure
Financial Reporting Standards
Financial Services Act
Financial Sector Assessment Program
Financial Stability Executive Committee
Financial Systems and Payment Systems Report
Islamic Banking Act 1983
Internal Capital Adequacy Assessment Program
Islamic Deposit Insurance Fund
International Financial Reporting Standards
International Organization of Securities Commissions
Internal Rating Based
Labuan Financial Services Authority
Malaysian Accounting Standards Board

5
MI
MoF
SC
NPL
PDS
PIDM
PFMI
RM
RENTAS
ROSC
RTGS
RTO
SAA
SBL
SC
SCA
SKM
SME
SRU
SSS
SuRF
TIPS

Member Institution
Ministry of Finance
Securities Commission Malaysia
Non-Performing Loan
Private Debt Securities
Malaysia Deposit Insurance Corporation
CPSS-IOSCO Principles for Financial Markets Infrastructure
Malaysian Ringgit
Real Time Electronic Transfer of Funds and Securities
Report on Observance of Standards and Codes
Real Time Gross Settlement System
Recovery Time Objective
Strategic Alliance Agreement
Securities Borrowing and Lending
Securities Commission Malaysia
Securities Commission Act 1993
Cooperatives Commission
Small and Medium Enterprises
Specialist Risk Unit
Securities Settlement System
Supervisory Risk Based Framework
Takaful and Insurance Benefits Protection System

6
I. BASEL CORE PRINCIPLES FOR EFFECTIVE BANKING SUPERVISION
A. Summary
1.
This assessment of the current state of compliance with the BCPs in Malaysia
has been undertaken as part of a joint IMF-World Bank Report on the Observance of
Standards and Codes (ROSC) mission.1 The assessment was conducted in April 2012. It
reflects the banking supervision practices of the Bank Negara Malaysia (BNM) as at endMarch 2012.
2.
BNM employs a very well developed risk-focused regulatory and supervisory
regime, consisting of a hands-on and comprehensive program of onsite supervision and
extensive off-site macro and micro surveillance that is well integrated with its on-site
supervision. BNM supervisors are guided and assisted by a generally well articulated set of
risk management and internal control expectations, specified higher than international
minimum capital requirements, a comprehensive liquidity risk framework, and effective
coordination and information sharing with foreign supervisory authorities.
3.
There remain, however, several opportunities to improve the regulatory and
supervisory framework. New financial services legislation, the Financial Services Act
(FSA), seeks to address many of these gaps.2 For instance, a clear gap exists in the
application of the supervision and regulation regime to financial holding companies (FHCs).
Six of the eight large domestic banking groups have parent FHCs and the current legislative
framework does not by its terms apply to those firms on a parent or consolidated basis. The
BNM has been creative by imposing conditions on the FHCs, using legislative authority
applicable to affiliates of banks to apply reporting and examination requirements to the FHC
and its subsidiaries. More detailed regulation would be useful on interest rate risk in the
banking book, credit concentrations, country risk, and operational risk. The transparency of
the criteria applied for new licenses and for acquisitions could be improved. Finally, there
exit opportunities to better focus the information sharing arrangements with the SC and
strengthening the legal protection available for supervisors. There are also some broad policy
issues on the relationship between BNM and MOF, and between BNM and the Malaysia
Deposit Insurance Corporation (PIDM) that should be reviewed.

The assessment was conducted by William Rutledge (consultant to the IMF) and Katia D'Hulster (World Bank
staff).

The FSA was passed in December 2012; implementation will follow Royal Assent, probably by mid-2013.

7
B. Institutional Setting and Market Structure Overview
4.
The banking sector, which accounts for half the financial system, is well
capitalized and profitable. The onshore banking sector—with assets of some 200 percent of
GDP—comprises nearly 50 percent of financial sector assets (Islamic banks are around
20 percent of the banking sector) and Labuan IBFC banks an additional 3 percent. The top
5 domestic banking groups comprise nearly 62 percent of total banking system assets. The
banking sector’s asset quality remained healthy with steady improvement in gross NPL ratios
to 2.7 percent in 2011. Total provisions (general and specific) were 99.4 percent of NPLs;
NPLs net of specific provisions stood at 1.8 percent. Banks remain well capitalized with
system-wide risk-weighted capital ratio and core capital ratios at 15.6 percent and
13.6 percent respectively in 2011.
5.
Non-bank credit intermediation is sizable, at some 90 percent of GDP. This is
accounted for predominantly by the state-run Employee Provident Fund, insurance
companies, and DFIs. The EPF and insurance companies invest the majority of their
portfolios in the domestic bond market, in both government and private debt securities. DFIs
provide credit via direct lending to targeted sectors such as agriculture, SMEs, infrastructure,
maritime, export-oriented sector, high-technology and capital-intensive industries. They are
well capitalized.
C. Preconditions for Effective Banking Supervision
6.
The legal framework in Malaysia is based on a common law legal system. Laws
are enforced through a single structured judicial system consisting of superior and
subordinate courts whose decisions are enforceable, with avenues for appeal consistent with
common law systems. In addition to the court system, alternative mechanisms for resolving
disputes and debts also exist. These include arbitration, mediation, credit counseling, and
debt management and restructuring services.
7.
Accounting and auditing services are well developed and provide a sound basis
for credible disclosure and resultant market discipline. Companies are required to prepare
their accounts based on approved accounting standards issued by the Malaysian Accounting
Standards Board (MASB). Public interest entities (including banking institutions) are
required to report their accounts using Financial Reporting Standards set by the MASB,
which is in compliance with IFRS both in terms of content and timing of implementation.
Companies’ accounts are required to be audited annually by approved auditors. Reports and
the audit procedures performed are in compliance with the National Auditing Standards,
which are in full compliance with the International Standards on Auditing.
8.
The Malaysian Electronic Clearing Corporation, a wholly owned subsidiary of
BNM, operates RENTAS, a real time gross settlement system for interbank funds
transfer, a securities settlement system and a securities depository for all unlisted debt

8
instruments. RENTAS is also linked with the USD Clearing House in Hong Kong to
mitigate for settlement risk for Ringgit-USD foreign exchange transactions.
9.
The credit information services industry in Malaysia consists of agencies from
both the public and the private sector. The Centralized Credit Reference Information
System is operated by BNM. It collects and disseminates credit information from and to
participating financial institutions. Private sector credit reporting agencies include Credit
Bureau Malaysia, RAM Credit Information, Financial Information Services and CTOS and
are regulated by the Registrar of Credit Reporting Agencies.
10.
The deposit insurance system is administered by the PIDM and provides
coverage for conventional and Islamic deposits, for all type of depositors, whether
business or individuals. The maximum limit of coverage is RM 250,000 per depositor per
member institution. All commercial and Islamic banks, domestic and foreign, are member
institutions of PIDM and are subject to a risk based differential premium system.
11.
BNM has a broad range of powers to avert or reduce risks to financial stability.
These include intervention and resolution measures, with powers to reduce systemic risks
emanating from both regulated and non regulated entities and to stem institutional or market
liquidity shocks. In addition to the operational standing credit facility for banks to obtain
overnight liquidity, BNM has broad powers to provide liquidity assistance to any financial
institution through a range of instruments. A Financial Stability Committee (FSC) serves as
BNM’s internal high level forum responsible for discussing risks to financial stability and
deciding on the appropriate policy responses.
Box 1. Islamic Banking in Malaysia
Islamic banking refers to a system of banking that complies with Shariah law. Malaysia has recorded robust
growth in Islamic banking assets. Total assets in the Islamic banking sector (including DFIs) accounted for
22.4% of total banking system assets as at end-2011. In Malaysia, Islamic banking is mostly conducted through
separately incorporated banks. The 16 Islamic banks include ten which are domestically owned and six which
are foreign owned. Licensed commercial and investment banks are also given the flexibility to operate an
Islamic banking window, subject to meeting applicable standards and guidelines to ensure full Shariah
compliance – to date there are three commercial Islamic banking windows and seven investment banking
windows.
In a dual financial system in which conventional and Islamic financial products are offered in parallel, a critical
aspect of the regulatory framework is the consistency of rules and regulations across both sectors to eliminate
possibilities for regulatory arbitrage. At the same time, there is a need to reflect the differences in the nature of
risk inherent in Islamic financial products and services. Shariah requirements are observed in the formulation of
applicable standards through active involvement of the Shariah unit and consultation with the Shariah Advisory
Council on Islamic Finance established under the CBA 2009 (SAC) on any matters requiring ascertainment of
Islamic law.
The supervisory approach and practices for Islamic banks at the BNM are very similar to commercial banks.
The only major difference is that, in accordance with the risk based supervisory framework, an additional
operational risk i.e. that of Shariah compliance, is assessed for Islamic banks. This risk is analyzed in two ways;

9
Box 1. Islamic Banking in Malaysia (concluded)
first, as a compliance risk embedded in every significant activity, second as an overarching operational risk for
the whole bank. To assist with the specific detailed aspects of the assessment, a team of Shariah officers
including a Shariah compliance expert employed in the BNM Specialist Risk unit provides input.
The Islamic banks are governed by a separate Act (the Islamic Banking Act 1983 (IBA)). In some areas, the
IBA provides less legislative authority than the more recent Banking and Financial Institutions Act 1989
(BAFIA) which governs the conventional banks. The authorities state that effective implementation of a
comparable prudential framework has been conducted through guidelines issued pursuant to the general power
to issue guidelines under IBA and setting clear supervisory expectations on Islamic banks. Although the
assessors have not focused on Islamic banking, the BNM is confident that in practice it ensures consistent rules
and regulation across both sectors. There remain some areas where the legal and regulatory requirements as
well as the powers of the BNM are not formalized in the IBA.
For example
 The lack of explicit power for the BNM to revoke licenses for Islamic banks;
The IBA does not have a provision that allows the MOF, on recommendation of the BNM, to revoke a
license granted when BNM has been provided with false, misleading or inaccurate information in
connection with the application or after the grant of a license. Instead BNM may rely on contravention
of any provision of the IBA for revocation.
 Unlike BAFIA, there is no specific share ownership threshold driving the need for an application in
the IBA; however by regulation BNM has imposed the same 5 percent threshold.
 The IBA does not currently require external auditors to report matters of material significance to
the supervisor, for example failure to comply with the licensing criteria or breaches of banking or
other laws or other matters which they believe are likely to be of material significance.
 The lack of explicit power to obtain information from the holding companies of Islamic banks.
Hence, the BNM cannot currently conduct any examinations of holding companies or require holding
companies, controllers or significant owners or any group or related entities to provide information to
BNM for supervisory purposes. Most Islamic banks are held directly by a regulated banking
institution; but one Islamic bank is not part of a commercial banking group and is held by a holding
company. The BNM is of the opinion that it has been able to obtain relevant information relating to the
holding company from the Islamic banks.
 The lack of power for the BNM to access auditors’ working papers. In practice however the BNM
has not yet used this power for conventional banks.
 Where the law provides for certain decisions to be referred to the MOF, BAFIA explicitly provides
that decisions by the MOF should be made upon the recommendations of BNM. This is currently
not explicitly available under the IBA.
Further enhancements are envisaged under the FSA to streamline legal and regulatory requirements and powers
of BNM in regulating the Islamic financial sector alongside the conventional financial sector. Major parts of the
IFSA, for instance licensing, regulation and supervision of financial groups and examination powers, contain
mirror provisions to the FSA to ensure consistency of rules and regulation across both sectors and eliminate
potential regulatory arbitrage (about 75% of the provisions in IFSA are the same as in the FSA). In addition, the
proposed new legislation seeks to provide greater visibility to Shariah compliance and the effective
implementation of Shariah governance by Islamic financial institutions, thus ensuring a coherent regulatory
framework. Among others, proposed provisions have been put forward to allow BNM to specify standards on
Shariah matters, including rules relating to Shariah governance, principles and practices of Shariah in relation to
the business and affairs of an Islamic institution, as well as requirements for Shariah compliance audits. In line
with Shariah requirements, the proposed new law will also clarify the nature of Shariah contracts employed in
conducting Islamic banking business and the process and priority of payments in the event of a winding up of a
financial institution involved in Islamic financial business.

10
D. Main Findings
Objectives, Independence Powers, Transparency, and Cooperation (CP 1)
12.
The role of BNM and other authorities is clearly defined in law. The statutory
responsibilities and objectives of BNM are stated in the CBA and BAFIA, supported by
internal governance arrangements. The adoption of the new Policy Framework will increase
the transparency in policy activities. Governance arrangements (including operational
procedures) and the roles/responsibilities of various functions within the BNM have yet to be
more explicitly defined. The BNM is well funded and its staff has credibility based on their
professionalism and integrity.
13.
The assessors found some instances in the legal framework where the Minister
could interfere with BNM’s independence. In practice, however, the assessors have not
come across evidence of de facto government or industry interference. It would provide
greater legal certainty regarding the independence of the BNM if these provisions were
removed and the independence of the BNM were formally grounded in the law.
14.
Legal protection for bank supervisors is in place and as a matter of practice the
employees costs of defending actions made while discharging their duties in good faith
would be borne by the BNM. But some enhancements could be made. Ideally, the CBA
should specifically state that the legal protection provided to the BNM employees is not
limited in time (i.e. provides protection beyond the termination of appointment or
employment). Also, at the minimum, it is necessary that protection against incurring the costs
of defending the actions of supervisors is stated clearly and explicitly (at least at the level of
internal procedures).
15.
BNM has a good framework for information sharing with foreign supervisors,
but domestic information sharing arrangements could be improved. The MOU with the
SC should be expanded to cover more than the investment banks that the SC and BNM coregulate.3 Information sharing with the SKM could also be formalized. Finally, the BNM
should consider entering into MOUs with countries of major new entrants (e.g., Japan).
CP 2-5 Licensing and structure
16.
The Malaysian banking law appropriately defines and controls the business of
banking, with Bank Negara strongly overseeing the evolution of the banking structure,
with some areas of needed concurrence (e.g., license approval) from the Minister of
Finance. BNM has presented publicly long term plans for banking and financial structure
that have guided ongoing decision-making—as the country responded to the Asian banking
crisis of the 1990s by consolidating banks into the current eight large banking groups that
3

The October 2012 update to the BNM-SC MoU addresses these issues.

11
dominate the domestic market. Since that consolidation, the structure has been kept relatively
stable with no new licenses for conventional commercial banks granted from 1970 until
2009; consistent with the long run plan to encourage the development of the Islamic banking
sector, a number of Islamic bank licenses have been granted since 2004. There has been little
public transparency on the criteria used in BNM’s review of licensing and acquisitions that
have occurred in recent years, as BNM has chosen to share expectations only directly with
the applicants. Enhancing transparency and ensuring that appropriate focus is given to
shareholders of banks in addition to the applicant banks are areas where improvements can
be made.
Prudential Regulation and Requirements (CPs 6-18)
17.
The BNM has set prudent and appropriate minimum capital adequacy
requirements but the scope of application of capital requirements should be widened to
include the FHC. Banks are well capitalized with strong system-wide risk-weighted capital
ratio and core capital ratios. The BNM has accredited ten banks to adopt the Basel II
foundation IRB approach for credit risk and two banks to adopt the standardized approach for
operational risk. The BNM does not have the power to include the FHC in the scope of
application of capital adequacy requirements (the new FSA should remedy this gap).
Basel III implementation is planned in accordance with the international timetable.
18.
BNM issued comprehensive guidelines specifying the requirements and
regulatory expectations for banking institutions to have in place an effective system for
management of problematic assets and processes to ensure the adequacy of provisions
and reserves. In the event that BNM has supervisory concerns over banking institution’s
asset quality and adequacy of provisions, BNM has the power to require banks to increase the
level of provisions and reserves as well as banking institutions’ financial strength via higher
minimum capital requirements. The regulations as well as the supervisory framework cover
the overall credit risk process in terms of identification, management and mitigation.
19.
The assessors identified several other areas for strengthening of prudential
regulation. More detailed regulation and supervisory expectations in the area of interest rate
risk in the banking book, credit concentrations, operational risk and country risk are
recommended. Also, the BNM should formally require banks to have a separate and
independent risk management unit. The BNM has recently released prudential regulations
covering Pillar 2 and many banks are making good progress towards their implementation.
That said, full implementation is required to further strengthen oversight of interest rate risk
in the banking book and credit concentrations.
Methods of Ongoing Banking Supervision (BCP 19-21)
20.
BNM supervises the activities of banks with a well-structured risk focused
supervisory approach that integrates well on-site supervisory practices, extensive

12
regulatory reporting, and off-site monitoring. BNM’s Supervisory Risk-based Framework
provides a strong structure for supervisors to carry out consistent and effective supervision,
both through individual firm supervision and through horizontal or thematic reviews.
Decision-making within this structure, as to onsite reviews to be conducted and special offsite surveillance work, is carried out by teams of supervisors headed by a Relationship
Manager (RM). The supervision work carried out by the RM and his/her team is supported
by micro-surveillance personnel, a macro-surveillance unit and a Specialized Risk Unit
(SRU). A careful system of checks and balances has been implemented, involving vetting of
ratings and other supervisory products through at least one, and sometimes two, layers of
independent panels within the Supervision Department. Ratings and supervisory
recommendations and remediation requirements are conveyed effectively to banking
institutions in writing, and through extensive interaction with the Board and senior
management; necessary remediation is followed through in a highly disciplined way.
21.
Emerging global practices are being introduced and BNM has incorporated
increasingly sophisticated supervisory techniques and expectations into its risk focused
approach. There are challenges in ensuring that appropriately specialized supervisory
expertise is maintained, and utilized to maximum effect. BNM is moving forward to
incorporate Basel II, Pillar 2 and ICAAP expectations, and will soon be looking to address
recovery and resolution planning. BNM currently has relatively few specialists in the SRU,
and the bulk of those experts’ time is spent in-house, providing guidance to the general
supervisors. As BNM has found with model validation requirements, specialized risk people
can provide major contributions on-site. Over time, the assessors expect that the cadre of
specialized people should be expanded, and more of their time spent in direct interaction with
bankers.
Accounting and disclosure (CP 22)
22.
The BNM has adequate regulations in place in the area of accounting and
disclosure by banking institutions. The BNM approves the external auditors for banks on
an annual basis and maintains an ongoing dialogue with them during the course of the audit
cycle. Feedback from market participants reflected a need for clearer communication of
auditors’ supervisory expectations to banks. Hence, assessors recommend the BNM more
clearly communicate to banks its supervisory expectations, particularly in case additional
procedures, may be required on top of the normal audit procedures.
Corrective and Remedial Powers (CP 23)
23.
BNM has broad discretion in the range of remedial actions it can take to address
problem situations, which it takes within a well designed early intervention program.
BNM’s Supervisory Intervention Guide sets out a clear set of steps to take if a bank’s
condition deteriorates and its risk increases, with BNM having the clear power to issue
directives to banks to take appropriate remediation actions.

13
24.
A new Strategic Alliance between BNM and PIDM was agreed while the BCP
review was taking place, and its effectiveness should be reviewed over time. Among the
issues to address is how the assessment of the viability of an institution is to be made (and
how transparent the criteria should be) and how the resolution framework could be applied to
financial holding companies.
Consolidated and Cross-border Banking Supervision (CP 24-25)
25.
A clear gap exists in BNM’s legislative authority for the supervision and
regulation of FHCs. The BNM has been effective in narrowing (but not eliminating) the
gap, and the proposed new FSA would address the statutory shortcoming. Six of the eight
large domestic banking groups have parent FHCs, and the current legislative framework does
not by its terms apply to those firms on a parent only or consolidated basis. Many of the
affiliates of the bank are regulated by the BNM, but some (such as asset managers) are not.
The BNM has been creative by imposing conditions on the FHCs incident to approval of
their investments in their banks, covering the nomination of their directors and CEO,
acquisitions of shares of other companies, the issuance of capital instruments, and more
generally complying with BNM guidelines. BNM has also used legislative authorities
applicable to affiliates of banks to apply reporting and examination requirements to the FHC
and its subsidiaries. Through these means, the BNM has been able to significantly reduce the
existing gap, but not to completely eliminate it. No consolidated capital ratios apply to the
FHCs; the liquidity framework does not apply on a consolidated basis; and no stress testing
expectations are applied on a consolidated basis. The proposed legislative change, if enacted,
would address many of these issues.
26.
BNM has a very well developed program of information exchange and
supervisory cooperation with an appropriate set of foreign supervisors, although it
could make some elements of information exchange globally and domestically more
formal. BNM has put in place an extensive set of MOUs and less formal information
exchange mechanisms with a relevant set of international supervisors. In addition it has been
active in hosting and participating in supervisory colleges and carrying out its own program
of overseas examinations. It has also been in the forefront in offering training programs to
other supervisors in the region. As a matter of good practice going forward, BNM should, in
licensing foreign banks subsidiaries, do a formal independent assessment of consolidated
home country supervision and look to enter into MOUs with countries of the major new
entrants. BNM’s MOU with the SC should be modified to make it much more directed to
consolidated supervision, and an MOU with the Cooperatives Commission should be
negotiated.

14
Table 1. Summary Compliance with the Basel Core Principles—Detailed Assessments
Core Principle
1. Objectives,
independence,
powers, transparency,
and cooperation
1.1 Responsibilities
and objectives

1.2 Independence,
accountability and
transparency

1.3 Legal framework

1.4 Legal powers

Comments

Laws are in place for banking and the role of BNM is clearly defined. Clear
responsibilities and objectives for other authorities are also in place.
The BNM has issued the “Financial Sector Blueprint 2011-2020”, a
strategic plan that lays out the future direction of the Malaysian financial
system.
The assessors recommend the BNM uses stronger language in its
guidelines and recommendations, clearly stating that banks “must”
observe the regulatory requirements instead of “shall” observe the
regulatory requirements. This will be addressed by the BNM’s Policy
Development Framework which was rolled out for implementation on 17
May 2012.


Transparency in the policy activities of the BNM could be
increased. This will be achieved by the adoption of the new
Policy Framework.
 Governance arrangements (including operational procedures)
and the roles/responsibilities of various functions within the
BNM have yet to be disclosed to the public for clarity and
accountability.
There are some instances in legal framework where the Minister could
interfere with BNM’s independence. For example, Section 70 in BAFIA
allows the Minister at any time to direct the Bank to make an examination
of the books or other documents, accounts and transactions of any
licensed institution if he has certain suspicions with regard to a banking
institution. Also, Section 15 of BAFIA allows companies to use the word
“bank”, “banking” (…) or any derivatives of this word with the explicit
approval of the Minister. Furthermore, Section 73 of BAFIA authorizes
BNM to direct institutions to take corrective actions, with the concurrence
of the Minister remove and/or appoint new officers and directors; the BNM
can also recommend to the Minister the revocation of a banking license
and approval of transfer of significant ownership.
In practice, however, the assessors have not come across evidence of
Government interference which would seriously compromise the
independence of the BNM. It would provide greater certainty regarding the
independence of the BNM if these provisions were removed and the
independence of the BNM were formally grounded in the law.
 The BNM will further enhance transparency by wider public
consultation on proposed policy measures in accordance with
the Policy Development Framework.
 For the sake of transparency, the BNM should align the
terminology used in its regulations. Circulars, guidelines and
best practices are generally considered binding for banks and
there may not be any need to distinguish between them.
BNM has the authority to address compliance with laws and safety and
soundness concerns through a broad grant of legislative authority.

15
Core Principle

Comments

1.5 Legal protection

Staff and persons appointed by the BNM are covered by the statutory
immunity clause for any action taken in good faith in pursuance of their
duties.
The assumption of the legal cost for defending against lawsuits faced by
individual supervisor could be anchored in the law.
The legal coverage should not depend on the person’s employment status
at the time of the lawsuit; former employees should be explicitly included.
Further, consideration should be given to include a provision permitting the
BNM to indemnify these persons for their legal costs in the event they are
sued.
BNM has a good framework for information sharing with foreign
supervisors, but information sharing arrangements could be improved
through:
 expanding the MOU with the SC to cover more than the
investment banks that the SC and BNM co-regulate (i.e.to
include asset management companies), and provide for the SC
to share information with BNM and for BNM to alert the SC of
supervisory developments in the broader banking group that
could affect those institutions within the group regulated by the
SC.
 more formalized information sharing with the SKM.
 the BNM entering into MOUs with countries (e.g., Japan) of
major new entrants.
The existing legal and regulatory provisions appropriately define and
control the business of banking, including, in particular, deposit-taking.
There are some deposit-taking companies not regulated by BNM.
BNM has a conservative program for the granting of new licenses, where
in the exception of the explicit inviting of companies to apply for a
stipulated set of new licenses (as occurred in 2009), no applications for
conventional commercial banks have been considered in forty years. New
legislation (FSA) would, at such time as it is enacted, deal with many of
the limitations in the current approach, listed below, but in any event,
going forward BNM should address the following:
 Reflecting the infrequency with which applications have been
entertained, the degree of transparency in the criteria to be
applied has been less than in other countries and should be
improved.
 The focus of the application review was most heavily on the
immediate applicant, although some review is done of ultimate
shareholders. The criteria should explicitly include an
assessment on the nature and sufficiency of financial
resources and the integrity of the shareholder.
 In the case of foreign banks, there is no explicit independent
evaluation of the nature and degree of consolidated regulation
and supervision applied by the home country supervisor, as
review is focused essentially on available FSAPs.
 Criteria on the suitability of officers (covering more of the senior
team than the CEO) and the achievability of business plans
need to be more explicit;
The framework for controlling the ownership of banks is a good one, but
should be refined:
 BNM must have the capacity to address directly unauthorized
acquisitions of shares, or control, of a banking institution, such

1.6 Cooperation

2. Permissible
activities
3. Licensing criteria

4. Transfer of
significant ownership

16
Core Principle

Comments
as requiring divestitures and/or cessation of control.
BNM should have an ability to learn about and deal with
changes in the suitability of major shareholders.
Overall approach is effective but there are some improvement
opportunities:
 BNM should look to codify criteria more explicitly for major
acquisitions.
 BNM needs more explicit authority to take corrective action
against non-banking companies that could be acquired if they
subsequently prove to be detrimental to the interests of the
bank affiliate.
Banks remain well capitalized with system-wide risk-weighted capital ratio
and core capital ratios at 14.9 percent and 12.9 percent respectively in
2011.
The scope of application of the capital framework should be widened to
include financial holding companies, as outlined in the Basel II scope of
application.
Some other, but minor, amendments to fully align the capital framework
with the BCBS standards should also be made. The assessors, however
believe the impact not to be material, particularly in view of the other
areas where the BNM is stricter than the Basel minimum.
Basel II consists of three mutually reinforcing pillars; the BNM should
therefore also fully implement Pillar 2 as soon as possible. Having a Pillar
1 and Pillar 3 in place without a fully fledged Pillar 2 process is, strictly
speaking, not in line with the sound Basel II implementation.
Moving forward, BNM will have enhanced legal powers under the new
financial services legislation to enable the application of capital
framework on financial holding companies and is in the process of fully
aligning the definition of capital with the implementation of Basel III in
Malaysia.


5. Major acquisitions

6. Capital adequacy

7. Risk management
process

8. Credit risk
9. Problem assets,
provisions, and
reserves

BNM has a good framework for risk management, but there are some
improvement opportunities:
 Increase the number and experience level of risk specialists and
ensure they spend more time in the field (currently, other than model
validation reviews, such specialists only occasionally do on-site
reviews);
 Ensure that under the current law that prudential risk management
policies are explicitly and consistently applied to consolidated FHCs;
 Ensure in particular that relevant stress tests are applied to
consolidated FHCs.
 BNM needs to issue a guideline that specifically requires banks to
have a dedicated unit responsible for the risk management
process.
The regulations as well as the supervisory framework cover the overall
credit risk process in terms of identification, management and mitigation.
BNM is in compliant with Principle 9. BNM issued comprehensive
guidelines specifying the requirements and regulatory expectations for
banking institutions to have in place an effective system for management
of problematic assets and processes to ensure the adequacy of provisions
and reserves.
In the event that BNM has supervisory concerns over banking institution’s
asset quality and adequacy of provisions, BNM has the power to require

17
Core Principle

10. Large exposure
limits

11. Exposure to
related parties
12. Country and
transfer risks

13. Market risks

14. Liquidity risk

15. Operational risk

Comments
banks to increase the level of provisions and reserves as well as banking
institutions financial strength via higher minimum capital requirements.
Generally speaking, laws, guidelines and supervisory practices are in
place to ensure banking institutions’ large exposures are prudently
managed.
Some enhancements can be made in the following areas:
 a more comprehensive definition of “a group of connected
counterparties” including the notion of economic dependency;
 a more active use of Pillar 2 to identify and assess credit
concentrations; and
 the alignment of the large exposure limits with international
best practice
The BNM is planning to issue a revised guideline for credit concentrations:
The revised guideline is expected to comprehensively address all the
requirements of Principle 10. Specifically, the enhancements to the
guidelines include:
 Clear and specific risk management expectations on
compliance with the prudential limits; and
 Comprehensive guidance on determining interconnectedness
of counterparties;
 Review of prudential limits; and
 Guidance on measurement of exposures to properly reflect
exposures and ensure consistency.
While the overall approach to connected lending is generally sound, the
exclusion of some significant minority shareholders is a gap that should be
addressed.
Although the assessors are broadly satisfied that country risk is identified
and assessed on a timely basis as part of the supervisory framework,
there is a need for more explicit legal and regulatory requirements on
banks in the area of country and transfer risk. With the growing
internationalization of the Malaysian banking system, the BNM should
expect that country and transfer risk be managed as a separate risk
category.
The BNM is to be commended for its periodic internal reporting on country
risk.
The regulatory guidelines are comprehensive and clear with regard to the
trading book.
The assessors recommend more market risk specialists are trained in
market risk.
The assessors recommend the risk specialist accompany the supervisor
on onsite examinations for higher risk institutions.
The regime for bank liquidity risk management is a sound one, but
improvements could be made in the application of the regime to FHCs.
 BNM supervisors need to conduct ongoing reviews of FHC
consolidated liquidity
 BNM needs to require that an FHC conducts a consolidated liquidity
stress test and table the stress test results at ALCO.
Although high level operational risk management requirements are
generally in place and adhered to, the assessors recommend
 the release of more detailed regulation
 the training of more supervisors in the operational risk specialist risk
stream
 operational risk specialists attend on site examinations for higher risk

18
Core Principle

16. Interest rate risk in
the banking book

17. Internal control
and audit
18. Abuse of financial
services
19. Supervisory
approach

20. Supervisory
techniques
21. Supervisory
reporting

22. Accounting and
disclosure

Comments
institutions.
BNM is currently developing an Operational Risk Reporting System to
upgrade eFIDS into a full-fledged operational risk event and loss reporting
system, for increased surveillance capability as well as for information
sharing with the industry. This will include revision to the fraud taxonomy
to cater for fraud events that are inherent in investment banking activities.
The system is expected to be operational in the first quarter of 2013.
The BNM is already addressing the first recommendation by drafting the
Operational Risk Management Guidelines. The guidelines will also
mandate the reporting of all operational risk loss events.
The assessors reviewed the assessment of IRRBB as part of their review
of a number of supervisory files and were satisfied with the depth and
scope of the individual institutions’ and horizontal reviews. That said:
 There is currently no regulation addressing IRRBB; and
 Feedback from banks indicated this is an area where
supervisory expectations need to be clarified; and
 More specialists need to be trained in IRRBB and they should
attend the onsite inspections for higher risk institutions.
BNM has a strong program for ensuring that effective governance,
staffing, and processes are in place for the important control functions of a
bank. The BNM focuses heavily and effectively on offering director training
programs.
The assessors recommend AML/CFT Specialists join onsite BNM
supervisors for the examination of higher risk banks.
BNM has a well developed framework of supervision with a strong
mechanism to ensure effective and consistent analysis of risks, with
access to a variety of information sources to keep its assessments current.
We have several recommendations for improvement:
 Increase the number and experience level of risk specialists and
provide for their spending more time in the field;
 Revisit its methodology for assigning ratings to banks to provide
capacity to factor in more explicitly adverse effects from affiliates.
BNM has a strong and well structured supervisory program, using
appropriate supervisory techniques.
The assessors recommend BNM require at least annual physical sign off
of the prudential returns by the Senior Management of the bank. The
BNM is currently enhancing its on-line statistical reporting (i.e. the
Integrated Statistical System (ISS) Project) to incorporate a digital
signatory requirement by senior management for each submission by the
banks.
While the assessors commend the BNM for the legal provisions with
regard to the power of the BNM to require adjustments to the financial
statements and to obtain supporting evidence, they recommend BNM
discontinue the use of Section 41 (4) of Bafia. This specific article requires
the BNM to inform the banking institution in writing that the financial
statements and supporting documents are satisfactory in terms of form
and content. This requirement somehow interferes with the independence
and responsibility of the external auditor and unduly exposes the BNM to
reputational risk.
Feedback from market participants reflected a need for clearer
communication of auditors’ supervisory expectations to banks. Hence,
assessors recommend the BNM more clearly communicate to banks its
supervisory expectations in case additional procedures may be required
on top of the normal audit procedures.

19
Core Principle
23. Corrective and
remedial powers of
supervisors

24. Consolidated
supervision

25. Home-host
relationships

Comments


Look to strengthen the legislative basis for the determination of nonviability it is required to make for troubled banks.
 Determine the resolution approach for FHCs.
 Revise its MOU with the SC to strengthen the requirement on BNM to
notify the SC of actions being applied to the bank affiliate of an
investment bank or asset management company; the MOU is in the
process of being enhanced to provide for greater coordination and
cooperation between BNM and SC, and to provide for examinations
by BNM of entities within the financial group which are licensed by
the SC.
 Expand the penalties that can be imposed on individuals under Civil
Law.
BNM has been creative and largely effective in putting in place and
implementing a consolidated supervisory framework despite obvious
shortcomings in the enabling legislation as it applies to FHCs. BNM
recognizes the need to address the legislative shortcomings, which would
be extremely helpful, although some specific supervisory changes are also
recommended.
 Needs to move quickly to put in place explicit legislative authorities for
oversight and supervision of FHCs.
 Whether under the current or new legislation, formalize the
application of prudential regulatory provisions to the consolidated
organization.
 Needs to strengthen its guidance for the assessment of parent
companies.
 The MOU with the SC should be broadened to provide for SC sharing
with BNM of information on asset management companies and other
affiliates of a bank.
 BNM should have the authority to require the closing of foreign offices
or to impose conditions on their activities.
BNM has a very well developed program of information exchange and
supervisory cooperation with an appropriate set of foreign supervisors.
BNM has been in the forefront in offering training programs to other
supervisors in the region. Some recommendations for improvements;
 In licensing foreign banks subsidiaries, BNM should do a
formal independent assessment of consolidated home country
supervision.
 BNM should enter into MOUs with countries that have major
new entrants.

20
E. Key Findings and Recommended Action Plan
Table 2. Recommended Action Plan to Improve Compliance with the Basel Core
Principles
Reference Principle

Recommended Action



Objectives,
Independence, Powers,
Transparency and
Cooperation (CP 1)







Licensing Criteria (CP3)





Transfer of Significant
Ownership (CP4)




Major Acquisitions
(CP 5)

Capital adequacy (CP6)

Remaining provisions in law requiring consultation with the Minister for
supervisory actions should be removed and the independence of the BNM
formally grounded in the law.
Expand the MOU with the SC to: cover more than the investment banks
that the SC and BNM co-regulate (i.e., to include asset management
companies and unit trusts which can also be part of banking groups);
provide for SC to share information with BNM on entities it supervises
within FHCs; and provide for BNM alerting the SC to supervisory
developments in the broader banking group that could affect those
institutions within the group regulated by the SC
Enter into more formalized information sharing arrangements with the
SKM;
Enter into MOUs with countries (e.g., Japan) of major new entrants.
Expand legal coverage so that former employees are explicitly included.
Consider including a provision permitting the BNM to indemnify these
persons for their legal costs in the event they are sued.
Reflecting the infrequency with which applications have been entertained,
the degree of transparency in the criteria to be applied has been less than
in other countries and should be improved.
The focus of the application review was most heavily on the immediate
applicant, although some review is done of ultimate shareholders. The
criteria should explicitly include an assessment on the nature and
sufficiency of financial resources and the integrity of the shareholder.
In the case of foreign banks, there is no explicit independent evaluation of
the nature and degree of consolidated regulation and supervision applied
by the home country supervisor, as review is focused essentially on
available FSAPs.
Criteria on the suitability of officers (covering more of the senior team than
the CEO) and the achievability of business plans need to be more explicit;
(the draft FSA, if enacted, will require the latter)
BNM must have the capacity to address directly unauthorized acquisitions
of shares, or control, of a banking institution, such as requiring
divestitures and/or cessation of control.
BNM should have an ability to learn about and deal with changes in the
suitability of major shareholders.
BNM should codify criteria for major acquisitions;



BNM needs more explicit authority to take corrective action against nonbanking companies that could be acquired if they subsequently prove to
be detrimental to the interests of the bank affiliate.



Expand the scope of application of the capital framework to include
financial holding companies, as outlined in the Basel II scope of
application.
Make amendments to fully align the capital framework with the BCBS
standards.
Fully implement Pillar 2.




Risk Management
Process
(CP 7)

Risk Management
Process
(CP 7)
Large Exposures (CP10)



Increase the number and experience level of risk specialists and ensure
they spend more time in the field, performing on-site review particularly at
large and complex banks;



Ensure that prudential risk management policies are explicitly and
consistently applied to consolidated FHCs, as is provided for under the
draft FSA;



Ensure in particular that relevant stress tests are applied to consolidated
FHCs.



BNY needs to issue guidance on the requirement for firms to have
separate risk management units.



Fully use Pillar 2 to identify and assess credit concentrations;



Reassess the change made to the definition of connected parties in 2008,
excluding significant (20%-50%) shareholders (unless they had a director)
and their subsidiaries and associated companies, from the definition
Introduce more explicit legal and regulatory requirements on banks in the
area of country and transfer risk.
Strengthen the supervisory framework by letting market risk specialist
participate in on site exams for higher risk institutions
BNM supervisors need to conduct ongoing reviews of FHC consolidated
liquidity

Related Parties (CP 11)
Country Risks (CP 12)
Market Risk (CP 13)





Liquidity Risk
(CP 14)

Operational Risk
(CP 15)

Interest Rate Risk in the
Banking Book (CP 16)
Abuse of Financial
Services (CP 18)



BNM needs to require that an FHC conducts a consolidated liquidity
stress test and table the stress test results at ALCO.



Release more detailed regulation and supervisory expectations in the
area of operational risk.



Train more specialists in operational risks specialist risk stream let them
accompany supervisors on onsite examinations, particularly for higher risk
institutions.



Release more detailed regulation and supervisory expectations in the
area of interest rate risk in the banking book.
Implement Pillar 2 fully.
Let AML/CFT specialists accompany supervisors during on site
examinations, particularly for high risk institutions.
Increase the number and experience level of risk specialists and provide
for their spending more time in the field;





Supervisory Approach
(CP 19)

Supervisory Reporting
(CP 21)



Revisit methodology for assigning ratings to banks to provide capacity to
factor in more explicitly adverse effects from affiliates



Require at least annual physical sign off of the prudential returns by the
Senior Management of the bank. The BNM is currently enhancing its online statistical reporting (i.e. the Integrated Statistical System (ISS)
Project) to incorporate a digital signatory requirement by senior
management for each submission by the banks.
Discontinue the use of Section 41 (4) of BAFIA. This specific article
requires the BNM to inform the banking institution in writing that the
financial statements and supporting documents are satisfactory in terms
of form and content. This requirement somehow interferes with the
independence and responsibility of the external auditor and unduly
exposes the BNM to reputational risk. (This provision is sought to be
removed in the proposed FSA).



22
Accounting/Disclosure
(CP 22)

Supervisors’ Corrective
and Remedial Powers
(CP 23)

Consolidated
Supervision (CP 24)

Home-Host
relationships (CP 25)



Ensure clear communication to banks in case additional external audit
procedures are required.



Look to strengthen the legislative basis for the determination of nonviability it is required to make for troubled banks.



Determine the resolution approach for FHCs.



Revise its MOU with the SC to strengthen the requirement on BNM to
notify the SC of actions being applied to the bank affiliate of an investment
bank or asset management company.



Expand the penalties that can be imposed on individuals under Civil Law.



Put in place explicit legislative authorities for oversight and supervision of
FHCs.



Whether under the current or new legislation, formalize the application of
prudential regulatory provisions to the consolidated organization.



Strengthen the guidance for the assessment of parent companies.



The MOU with the SC should be broadened to provide for SC sharing with
BNM of information on asset management companies and other affiliates
of a bank.



BNM should have the authority to require the closing of foreign offices or
to impose conditions on their activities.



In licensing foreign bank subsidiaries, BNM should do a formal
independent assessment of consolidated home country supervision
BNM should enter into MOUs with countries (e.g., Japan) with major new
entrants.



F. Authorities’ Response to the Assessment
27.
The Malaysian authorities wish to express their appreciation to the assessment
team for their comprehensive work and high degree of professionalism in conducting
the assessment. We value the candour in the interactions we had with the members of the
assessment team which enabled us to exchange ideas and insights as the Bank continues
ongoing efforts to further strengthen the supervisory and regulatory regime for the Malaysian
banking sector.
28.
The assessment concludes that the Malaysian banking sector is supervised under
a well developed risk-focused and comprehensive regime. The areas of recommendation
largely correspond with the Bank’s current priorities to further strengthen the regulatory and
supervisory system, and validate the various initiatives that are at advanced stages of
implementation or for which definite plans have been put in place. These measures will place
the Malaysian banking sector on a stronger footing as they expand in scope and geographic
reach.
29.
A significant number of the recommendations will be addressed by the proposed
financial services legislation. Amongst others, this will provide greater clarity in licensing
standards, suitability requirements for shareholders, powers to address unauthorized

23
acquisition of shares, powers for enforcement of corrective actions, and the regulation and
supervision of financial holding companies. A number of regulatory standards are currently
being revised to enhance the framework on risk management, large exposures and corporate
governance, and the issuance of the Risk Governance guidelines in the second half of 2012
will set explicit expectations on the need for a dedicated risk management unit within banks.
With regard to Basel II implementation, the supervisory expectations for Pillar 2 is already in
place and beginning 2013, the full supervisory review and examination process will be
conducted on all banks. The report mentions in several places that additional supervisory
resources, especially in the specialist risk areas, are likely to be required to continue to
deliver on and to augment supervisory practices. This is being addressed as part of the
organizational development initiative and the participation of specialist risk units in the onsite examination exercises will be intensified moving forward. On the comment regarding
legal protection for past employees, the legal provision applies to both current and former
employees of the Bank, as long as the suit against him is in respect of an act committed or
statement made by him in his capacity as an employee of the Bank, and in good faith. As
such, it is not necessary to expressly distinguish former employees in the legislation.
30.
In line with increasing regional and international financial integration, a HomeHost Supervisory Cooperation framework has been put in place to affirm existing
arrangements with foreign supervisors to ensure effective sharing and flow of
information. Domestically, the Strategic Alliance Agreement with the Malaysia Deposit
Insurance Corporation has since been revised to specify the triggers for non-viability and the
Memorandum of Understanding with the Securities Commission is being enhanced to
provide for clear arrangements with respect to the assessment of entities within a financial
group. The current practice of having bilateral and trilateral engagement with external
auditors will also be better documented and shared to set clear the expectations placed on the
external auditors.
31.
For BCPs that were assessed as compliant, we will seek continuous
improvements particularly in light of the revised BCP that will be introduced in the
near future.

24
II. ASSESSMENT OF INSURANCE CORE PRINCIPLES (ICPS)4
A. Summary, Key Findings, and Recommendations
32.
Bank Negara Malaysia (BNM) is a highly respected insurance regulator: the
regulatory guidance is comprehensive, and the supervision is effective and well-focused.
BNM has the capacity and is taking proactive steps to address shortcomings in the insurance
regulatory framework to achieve full observance of the ICPs. The proposed financial
institutions legislation5 should address concerns with BNM’s powers for group-wide
supervision and ensure that client monies with intermediaries are properly protected. The
implementation of the Internal Capital Adequacy Assessment Process (ICAAP), and new risk
governance guidance, will close current gaps in BNM’s formal expectations for better risk
management practices by insurers. Lastly BNM is not a home supervisor to any insurance
group, and cross-border activities of Malaysian insurers are not significant, so there may not
currently be a significant urgency for BMN to implement substantive measures to ensure it
can be effective in cross-border coordination during a crisis. Given the speed of change in the
financial sector, including the insurance industry, BNM should endeavor to seek continuous
improvements in its supervisory practices as well.
33.
The assessment did not reveal any current potential sources of significant risk to
Malaysian financial stability from its insurance industry. The sector continues to be
relatively small and fragmented, without any major risk accumulations that could pose
stability concerns. Insurers should continue be monitored to ensure they do not introduce
imprudent practices and instability within the industry, with special attention paid to those
that may not have an extensive track record of conducting business in Malaysia, such as new
entrants and insurers where there has been a recent change of control. Also, any substantial
growth in risk accumulations in Danajamin should be very closely monitored, given the
nature of its business risks and the incomplete regulatory framework that exists for financial
guarantee insurance. BNM has indicated that efforts will be taken to strengthen the
regulatory framework for financial guarantee insurance.
B. Introduction and Scope
34.
This assessment provides an understanding of the significant regulatory and
supervisory framework for the insurance sector of Malaysia. The market has been
growing for Islamic insurance products (family takaful, general takaful, and re-takaful). The
ICPs were not specifically developed with Islamic insurance products in mind. Consequently,
based on the agreed scope, details on the regulation, supervision and various workings of
4

The assessment was conducted by Mark Causevic (IMF Consultant; OSFI, Canada).

The FSA bill was passed in December 2012.

25
Malaysian Islamic insurance market are included in this report, but do not form part of the
ICP assessment ratings for Malaysia.
35.
The assessment is based solely on the laws, regulations and other supervisory
requirements and practices that are in place at the time of the assessment. Ongoing
regulatory initiatives are noted by way of additional comments e.g., proposed legislation.
C. Overview: Institutional and Macro Prudential Setting
Market Structure and Industry Performance
36.
While the market is fairly sophisticated, offering a wide range of life, non-life
and takaful insurance products, there is scope for further growth and consolidation.
Current industry challenges that BNM has identified and is addressing include asset-liability
matching in a low interest rate environment, rising claims costs and increased volatility in the
global markets.
37.
Access to and foreign ownership of the Malaysian insurance market is restricted.
No direct conventional insurance license has been issued since the 1970s. New reinsurance,
takaful and retakaful licenses have been issued from time to time since 1995 to meet specific
objectives to enhance domestic reinsurance capacity and further develop the takaful industry.
The foreign equity limit for insurers is 70 percent. A foreign equity limit above 70 percent
will be considered on a case-by-case basis, particularly for players that can facilitate
consolidation and rationalization of the general insurance industry.
38.
Four out of nine life insurers are owned by the large domestic banks and
domestic parties account for most of the ownership of the Malaysian general insurers.
Nevertheless, foreign-owned insurers have a major presence in Malaysia, with foreign-owned
insurers ranking as or amongst the largest insurers in the life and non-life sectors. Domestic
banks have major presence in the takaful market, with the dominant takaful operator being a
subsidiary of a large domestic bank.
39.
The cross-border operations of domestic insurers remained very small in terms
of size and span. In 2011, such operations involved total assets of RM979.8 million,
amounting to only 0.5 percent of total insurance industry assets, spanning four countries near
the Malaysian borders (Figure 1).
40.
Agency is the primary distribution channel for both life and general business.
The agency channel generates 59 percent and 65 percent of new premiums (life) and gross
premium (general), respectively. Bancassurance has also gained prominence in the recent
years because insurers can leverage on the banks’ existing network and customer base.
Bancatakaful is the main distribution channels in family takaful sector with 53 percent
contribution generated in 2011.

26
41.
The composition of insurance fund assets (including takaful business) remained
similarly stable with private debt securities (PDS) continuing to form the majority of
assets held (Figure 1). Market and credit risk exposures arising from holdings of PDS
remained manageable with the bulk of PDS held in high-grade papers (rated ‘A’ and above).
Insurers reduced holdings in equities during the year to 15 percent of assets as at end-2011,
in favor of less risky assets such as Malaysian government securities (MGS) and fixed
deposits which accounted for 17 percent and 13.6 percent of the industry’s total assets,
respectively. The rebalancing of investments maintained the market risk exposures of
insurers at 12.6 percent of capital available, with interest rate risk from higher investments in
MGS partly offset by lower equity risk exposures. Collectively, equity and interest rate risks
formed 84.6 percent of insurers’ total market risk exposures (Figure 2).
Figure 1. Insurance Sector: Composition of
Assets

Figure 2. Insurance Sector: Component of
Market Risk Exposure

Source: Bank Negara Malaysia, FSPSR 2011.

42.
A significant component of life insurance businesses are investment-linked
products which account for one third of the total new life business. Demand for
Investment-linked products has reduced significantly as a result of global market uncertainty.
The potential of the life industry can be further harnessed through the holistic pension review
being undertaken, including tax incentives to spur the private pensions industry.
43.
Takaful has experienced a double-digit growth in past five years with average
annual growth of 24 percent. Family takaful has contributed considerably to the growth in
contributions compared to general takaful fund, accounting for 85 percent of total funds
in 2011. Ordinary family products continue to be the key contributor to the new business,
while in general business is dominated by motor takaful.
44.
Malaysia is not a country that has significant natural catastrophe risks. While
flooding events can lead to significant gross insurance losses, commercial risks tend to be the
bigger source of large losses.

27
45.
The overall business retention level for general insurers is approximately
70 percent, but this varies widely by business class. Use of reinsurance is more
pronounced for large and specialized risks in the aviation, oil & gas and engineering classes
of business, where reinsurance premium ceded amounted to 94 percent, 93 percent and
56 percent of total premiums, respectively. In contrast, for motor insurance, the dominant
general insurance line in Malaysia, the retention rate approaches 90 percent. Malaysian
insurers reinsure a substantial part of risks underwritten in the global reinsurance market,
either directly or through reinsurance placements with Malaysian branches of foreign
reinsurers.
46.
While premium growth declined in 2011, capital adequacy continued to remain
strong. Persistent low yields and investment losses have been a drag on profitability.
Reinsurers recorded operating losses as claims from business interruption losses surged due
to the floods in Thailand. This sharply increased the overall claims ratio for fire business
(including cover for business interruptions) to 69 percent (2010: 36 percent). Underwriting
losses for motor third-party bodily injury insurance continued to pose downward pressure on
profitability with the claims ratio rising to a record high of 300 percent (2010: 280 percent).
The overall motor claims ratio (including ‘comprehensive’ business), however, improved to
77 percent. Despite weaker profits, the combined capitalization level of the general and life
insurance industry remained strong with the aggregate capital adequacy ratio (CAR) at
222 percent, well above the supervisory minimum capital requirement of 130 percent.
47.
All insurance sectors maintained strong average capital positions. The life sector
has shown a declining trend since 2009, while the average capital ratio for the general sector
has strong gains.
Institutional Framework and Arrangements
48.
Oversight of the Malaysian financial sector primarily performed by BNM and
the Securities Commission (SC). BNM supervises the banking sector (conventional,
Islamic, investment6 and development banks) as well as the insurance sector (including
reinsurance and takaful). It also licenses financial advisors, insurance brokers, and money
brokers, as well as oversees the money and foreign exchange markets; and the payment
clearing and settlement systems. The SC regulates the securities industry as well as
derivatives (other than exchange rate related OTC contracts). There is a stand-alone deposit
protection agency (PIDM). The Labuan Financial Services Authority (LFSA) covers all
offshore financial activities in Labuan (banking, insurance, fund management). The LFSA is
chaired by the BNM Governor and has a close working relationship with BNM. The two
main pension funds are state-owned and overseen by the Ministry of Finance. The SC

The SC shares responsibility for investment banks with BNM.

28
currently regulates the nascent private sector pension fund industry using fund management
regulations; separate pension regulations are to be introduced soon.
Malaysia is undertaking comprehensive changes to its legislative framework for
49.
the regulation and supervision of financial institutions. Proposed legislation, referred to as
the proposed Financial Services Act (FSA) and Islamic Financial Services Act (IFSA), aim to
consolidate and rationalize existing regulatory laws to achieve a more cohesive legislative
framework. A dual framework will be maintained for the conventional and Islamic financial
business consistent with the dual financial system in Malaysia. Within this dual framework,
the prudential and market conduct supervision of institutions and markets under BNM’s
purview will be integrated under the proposed new legislation, which will replace the
existing Banking and Financial Institutions Act 1989, Islamic Banking Act 1983, Insurance
Act 1996, Takaful Act 1984, Payment Systems Act 2003 and Exchange Control Act 1953.
Included in the proposed legislative changes are provisions to allow BNM to exercise
oversight over financial groups that have one or more licensed institutions within the group.
D. Preconditions for Effective Insurance Supervision
50.
The legal framework in Malaysia is based on the common law system. Law is
enforced through a single structured judicial system consisting of superior and subordinate
courts whose decisions are enforceable, with avenues for appeal consistent with common law
systems. In addition to the court system, alternative mechanisms for resolving disputes and
debts allow judicial resources to be conserved, while expediting case disposals.

Pursuant to the Companies Act 1965, companies are required to prepare their
51.
accounts based on approved accounting standards issued by the Malaysian Accounting
Standards Board (MASB). The financial statements should show a “true and fair” view of
the financial positions, financial performance and cash flow of an entity.
Public interest entities are required to report their accounts using Financial
52.
Reporting Standards (FRS) set by the MASB, which is in full compliance with
International Financial Reporting Standards (IFRS) as set by the International
Accounting Standards Board . IFRS is directly transposed into Malaysian FRS, adapted
where absolutely necessary. Any changes made are done with the sole objective of enhancing
the quality of reporting, and typically deal with only specific issues not dealt with in the
IFRS by illustrating or providing additional clarifications for better understanding or making
changes necessary to comply with local laws and regulations.
Companies’ accounts are required to be audited annually by approved auditors.
53.
Reports and the audit procedures performed are in compliance with National Auditing
Standards, which are in full compliance with the International Standards on Auditing.
Membership in the Malaysian Institute of Accountants (MIA) is a pre-requisite for
employment in Malaysia as a professional accountant or auditor and all members are
required to comply with the MIA By-Laws on Professional Ethics.

29
54.
Malaysia has a guarantee fund for the protection of owners of insurance policies
and takaful certificates. The Government has set up a Takaful and Insurance Benefits
Protection System (TIPS), administered by PIDM to protect owners of takaful certificates
and insurance policies from the loss of their eligible benefits in the unlikely event of an
insurer member failure. TIPS, one of the components of the Enhanced Financial Consumer
Protection Package established by PIDM was brought into effect on 31 December 2010.
TIPS is funded by annual premiums paid by member institutions. Part of the reserves also
came from the transfer of the Insurance Guarantee Scheme Fund, from BNM to PIDM. To be
eligible for protection under TIPS, the takaful certificate or insurance policy must be issued
in Malaysia by an insurer member and be denominated in Ringgit Malaysia. Based on the
limits and scope of coverage, 95 percent of all Takaful certificates and insurance policy
holders are protected in full.

E. Key Findings and Recommendations
Table 3. Summary Implementation of the ICPs
Insurance Core
Principle
1. Objectives,
Powers and
Responsibilities
of the
Supervisor
2. Supervisor

Comments
Existing legislation clearly defines BNM as the authority responsible for
insurance supervision, and BNM’s powers to administer and enforce the
enabling legislation (subject to Ministerial approval in many cases) for
insurance operators and intermediaries in Malaysia. Supervisory objectives
could be more clearly defined.
Legislation provides for BNM to be an operationally independent statutory
body. It also affords BNM directors, officers, employees and others working
on its behalf with appropriate legal protection, as well as requires them to
protect confidential information. Internal governance practices emphasize
committee decision-making, to promote soundness and consistency.
BNM’s operations are self-funded, with resourcing decisions fully within its
control. It has a practice of overstaffing in order to address turnover issues,
especially at entry-level positions. BMN offers a remuneration package that is
comparable to the industry, invests significantly in staff training, and requires
staff to follow a substantive code of conduct to promote high ethical
standards. BNM staff members are highly regarded by industry stakeholders.

3. Information
Exchange and
Confidentiality
Requirements

The transparency of BNM’s regulatory expectations, and the process for
regularly reviewing their continued appropriateness, could be enhanced.
There is an adequate legal and administrative framework in place that allows
BNM to exchange information, on entities it supervises, with other
supervisors and authorities subject to confidentiality, purpose and use
requirements.
BNM does not have explicit power to regulate and supervise authorised
financial or insurance holding companies and all their related entities, and so
does not have legal authority to directly obtain information from such entities.

30
Insurance Core
Principle

4. Licensing

Comments
BNM’s home-host Supervisory Framework (HHSF) aims to address specific
information sharing situations in a consistent manner. BNM has a very limited
number of MOUs in place for insurance supervision purposes.
Only licensed entities can lawfully conduct insurance activities in Malaysia.
Legislation establishes clear parameters for the allowable legal forms and
business activities of insurers, as well as the relevant licensing approval
authorities and their applicable powers.
In the absence of specific licensing criteria within legislation, BNM
established specific guidelines and communiqués to articulate the licensing
criteria, and information required for license application, during the limited
rounds of BNM acceptance of reinsurer and (re)takaful applications since
1995. No direct conventional insurance licenses have been issued since the
1970s.

5. Suitability of
Persons

6. Changes in
Control and
Portfolio
Transfers

The requirements and procedures for licensing are appropriately clear and
adequately administered within the parameters of the insurance market for
which access by new entrants is significantly restricted. In such
circumstances, applications that best meet objective criteria are approved.
Licensing approval criteria is not contained within existing legislation. The
proposed FSA is expected to address this.
An adequate legislative and BNM administrative framework exists to ensure
that Board Members, Senior Management and Key Persons in Control
Functions possess competence and integrity to fulfil their roles, both upon
and subsequent to their (re)appointment.
While significant owners are subject to suitability assessments upon
application for approval for licensing and significant changes in their
shareholdings, there are no requirements for significant owners to continually
comply with suitability requirements. The proposed FSA is expected to
address this.
Legislation clearly defines ‘control’, and approval is required for share
ownership transactions well below the level of ‘control’. The approval regime
for changes in an insurer’s ownership is two-staged. The first relates to the
commencement of negotiations, where BNM’s prior approval is required for
any party to enter into negotiations to transfer 5 percent or more shares of an
insurer. The second stage involves the details of the arrangement that will
result in the transfer of shares in an insurer, which under legislation requires
the Minister’s prior approval upon BNM’s recommendation. BNM effectively
uses licensing and suitability of persons criteria to assess such applications,
which includes financial and non-financial requirements.
Under legislation, any scheme of transfer for insurance or reinsurance
business has to be approved by BNM, and confirmed by the court (if the
transfer is in relation to business in Malaysia). Legal provisions and
administrative processes exist to protect policyholders under such
transactions.

31
Insurance Core
Principle

7. Corporate
Governance

8. Risk
Management
and Internal
Controls

9. Supervisory
Review and
Reporting

10. Preventative and
Corrective
Measures

11. Enforcement

Comments
Legislation does not explicitly outline approval criteria for the acquisition of a
significant ownership interests in insurers or for insurer portfolio transfers.
The proposed FSA is expected to address this.
Legislation provides broad, but limited, corporate governance requirements.
BNM outlines its corporate governance expectations for insurers through
various guidelines. Overall, the guidance is extensive in scope and reflects
high standards. The expectations are reinforced with insurers through BNM’s
supervisory focus on corporate governance and its mandatory training
program for financial institution directors.
Certain key corporate governance guidelines from BNM are due for review. In
particular, one key guideline was issued about ten years ago and contains
‘best practices’ which are more appropriately elevated to mandatory
standards based on BNM’s expectations of insurers today.
BNM outlines its risk management and internal control expectations for
insurers through various guidelines. Overall, while the expectations
articulated within BNM’s risk management and internal controls related
guidelines are wide in scope, and many reflect high standards, some key
regulatory guidelines are due for review. In particular, one key guideline was
issued about ten years ago and contains ‘best practices’ which are more
appropriately elevated to mandatory standards based on BNM’s expectations
of insurers today.
BNM’s supervisory framework is an integrated risk-based system that uses
both off-site monitoring and on-site inspections to assess the overall risk
profile of insurers - based upon their business activities, inherent risks, quality
of risk management, compliance with legislative and supervisory
requirements, and financial and solvency condition.
BNM collects extensive information, on both a regular and ad hoc basis, and
as deemed necessary to conduct effective supervision of insurers and to
evaluate the insurance market.
The legislative, administrative and supervisory frameworks in place promote
the ability for BNM to take timely, suitable and necessary preventative and
corrective measures to achieve supervisory objectives.
BNM’s early intervention supervisory approach under its Supervisory Riskbased Framework (SuRF), and increasing supervisory intensity and severity
of measures under its Supervisory Intervention Guide, allow for remedial
actions to be taken by insurers before problems become worse. BNM is
active in communicating prudential and non-compliance issues to insurers, as
well as in indicating actions and timeframes for corrective actions to be taken.
The legislation and administrative framework in place provides BNM with the
ability to pursue a wide range of enforcement actions. Many examples were
identified where BNM utilized a wide-range of substantive enforcement
powers under legislation. To ensure consistency, BNM decisions on
enforcement actions are made through internal committee, but it does not
make publically available information relating to the criteria or basis for its

32
Insurance Core
Principle

Comments
enforcement decisions or actions.

12. Winding-up and
Exit from the
Market

13. Reinsurance
and Other
Forms of Risk
Transfer

14. Valuation

15. Investment

16. Enterprise Risk
Management for
Solvency
Purposes

17. Capital
Adequacy

18. Intermediaries

While BNM does not have the authority to invoke some substantive
enforcement actions without Ministerial approval, this has not been seen as
practical impediment to BNM’s enforcement activities. The expansion of
available enforcement tools for BNM, and greater transparency of the basis of
enforcement decisions, would enhance BNM’s effectiveness.
There is an extensive legislative framework in place for the winding-up and
exit of insurers from the market, which provides for a range of failure
resolution options and appropriate priority protection for policyholders. Upon
BNM’s determination of insurance non-viability, PIDM is empowered to
intervene and resolve troubled insurers, with the aim of minimizing costs to
the financial system.
BNM has a well-established legal and administrative framework with respect
to the use of reinsurance, particularly for general insurers, with
communicated expectations that insurers adequately control and report on
their risk transfer programmes. BNM’s supervisory activities reinforce good
reinsurance management practices by insurers.
BNM’s key detailed guideline on reinsurance arrangements is due for review,
and currently does not extend to life reinsurance.
For solvency purposes, BNM effectively uses IFRS as the valuation basis
with prescribed requirements in certain areas outlined in BNM guidance. The
technical provisions reflect the present value of relevant cash flows, with a
margin over current estimate (MOCE), and a requirement for discounting for
life insurers.
Legislation and BNM guidelines set out prudential considerations for insurers’
investment management activities. In particular, BNM’s risk-based capital
(RBC) guideline addresses investment management expectations as well as
capital charges relating to investment risks. The guidelines do not fully reflect
BNM’s current expectations and do not address group-wide risks.
BNM has many guidelines that promote robust enterprise risk management
by insurers and governance activities appropriate to the nature, scale and
complexity of insurers operations. In particular, BNM’s RBC guideline
requires insurers to establish links between their risk and solvency capital
management activities. BNM’s planned near-term changes will address gaps
it has identified, particularly with respect to risk governance and ICAAP
expectations.
BNM has a RBC framework to adequately and explicitly capture insurers’
risks, on a total balance sheet basis, and provide for sufficient capital to
absorb significant unforeseen losses. It provides two explicit triggers to allow
for different degree of supervisory intervention. The RBC requirement is not
defined in terms of level of protection provided.
BNM has not developed a risk capital framework for financial guarantee
insurance.
Under legislation, BNM is empowered to license, regulate and supervise
brokers and financial advisors. BMN conducts assessments of the

33
Insurance Core
Principle

Comments
compliance by broker and financial advisor with regulatory requirements,
using that information as part of its process for license renewal decisions.
Agents are subject to the various self-regulatory requirements set out by their
industry associations. In practice, BNM works closely with those associations
to ensure appropriate requirements are set out. Also, BNM periodically
assess agents’ compliance with those requirements as part of its supervisory
activities at the insurer, and takes enforcement actions as necessary.

19. Conduct of
Business

20. Public
Disclosure

21. Countering
Fraud in
Insurance

22. Anti-Money
Laundering and
Combating the
Financing of
Terrorism

Legislation does not require the maintenance of separate fiduciary accounts
for monies collected from clients, but BNM indicates that this is observed in
practice by all insurance brokers and financial advisors. This gap is expected
to be addressed in the proposed FSA. Also, BNM is developing a supervisory
approach more specific to the relevant considerations for intermediaries.
Through the issuance of various consumer protection guidelines, BNM has
set many expectations for the conduct of business to ensure customers are
treated fairly. BNM conducts market conduct surveillance activities to assess
the adherence to its expectations. It is also involved in many consumer
education initiatives.
BNM’s effectiveness could be enhanced with strengthened enforcement tools
and the development and implementation of a supervisory framework specific
to market conduct activities. Both measures are being currently undertaken.
BNM’s public disclosure requirements leverage on requirements for all
insurers to effectively report using IFRS, with some additional requirements
imposed by various BNM guidelines. BNM actively promotes the public
dissemination of insurer information, both through its public disclosure
requirements on insurers, and through its own extensive publishing of insurer
and industry data on its website.
Beyond accounting requirements, BNM’s additional public disclosure
requirements are not extensive, and do not include certain disclosures
currently viewed as useful by analysts/ market participants.
Legislation has serious penalties for fraud activities. BNM has issued
guidelines to industry on fraud prevention and control activities, collects
insurance fraud data from insurers, conducts macro surveillance to determine
insurance fraud trends, and examination activities assessing insurer antifraud practices, and periodically shares data and intelligence on fraud matters
with police authorities.
Supervisory practices could be enhanced to more specifically address
insurers’ anti-fraud activities.
BNM is the designated AML/CFT competent authority in Malaysia. It has
taken a number of measures to ensure insurers and intermediaries take
effective measure to combat money laundering and the financing of terrorism,
including the issuance of guidelines, supervisory AML/CFT reviews, and
feedback sessions with industry.
BNM’s FIU is involved in various initiatives to identify issues and share
information relating to money laundering and the financing of terrorism. BNM
has signed 34 information sharing MoUs with foreign authorities.

34
Insurance Core
Principle
23. Group-wide
Supervision

Comments
There are no significant insurance groups for which BNM is the home
supervisor, For insurers belonging to a foreign financial group, under its
HHSF BNM shares information with other relevant supervisors as necessary
to facilitate the supervision of group-wide risks.
While BNM does not have explicit authority to regulate and supervise holding
companies and their related entities, as part of its supervisory approach,
BNM analyzes group entities for their ability to provide capital support and for
activities that may pose a risk to the financial condition of the regulated entity.
The group-wide analysis feeds into the development of the supervisory
strategy for the regulated entity.

24. Macroprudential
Surveillance and
Insurance
Supervision

25. Supervisory
Cooperation and
Coordination

26. Cross-border
Cooperation and
Coordination on
Crisis
Management

While BNM’s indirect approach mitigates some concerns, it is not an
adequate substitute for the range of additional tools available when there is
clear authority for group-wide supervision.
BNM conducts many activities around identifying, monitoring and analyzing
various market and financial developments, as well as other environmental
factors, which may impact insurers and insurance markets. Such work is
supported by the extensive data it collects from insurers and other sources,
some of which it publicly discloses for transparency purposes.
With some surveillance activities, a more structured approach would enhance
BNM’s effectiveness.
The Malaysian insurance sector has few insurance groups with cross-border
operations, and the Malaysian operations of foreign-owned groups are small
in relation to the overall operations of these foreign groups. There are no
significant insurance groups or financial holding company for which BNM is
home supervisor.
Nevertheless, BNM has an adequate legal and administrative framework in
place to allow it to effectively cooperate and coordinate with other relevant
supervisors and authorities on matters relating to the entities it regulates,
subject to confidentiality requirements. Many examples demonstrated BNM’s
openness to cooperating and coordinating with other relevant authorities.
Given the relative size and structure of the Malaysian insurance industry,
BNM expects that its role in effectively managing a cross-sector crisis
involving an insurer would be limited in most cases.
BNM has an adequate legal and administrative framework in place to allow it
to effectively cooperate and coordinate with other relevant supervisors and
authorities on matters relating to the entities it regulates. BMN also has
demonstrated its openness to cooperating/ coordinating with other relevant
supervisors and authorities.
BNM could further enhance its ability to contribute to the effective resolution
of an insurer cross-border crisis by increasing its expectations of insurers to
maintain comprehensive contingency plans and information systems capable
of generating timely and reliable ad hoc information on risk accumulation

35
Table 4. Recommendations to Improve Observance of the ICPs
Insurance Core
Principle

Recommendations

Objectives,
Powers and
Responsibilities
of the
Supervisor

To reduce the possibility of conflicting supervisory functions, legislative
amendments should be made to more specifically highlight the application of
BNM’s principal objectives to the supervision of the insurance sector for the
benefit and protection of policyholders. This is expected to be addressed in
the proposed FSA.

Supervisor

As transparency promotes greater accountability, BNM should move forward
with its plans to formalize a policy development framework and establish a
more liberal approach towards public disclosure of its regulatory expectations.
Subsequent to the assessment, BNM indicated that the policy development
framework was rolled out for implementation in May 2012.

Information
Exchange and
Confidentiality
Requirements

BNM’s should participate in more extensive MOU arrangements (including the
IAIS MMOU) with other supervisors so as to have a stronger foundation for
ensuring appropriate protection of shared information.

Licensing

In order to better support the consistent administration of licensing standards,
clear and objective licensing approval criteria should be incorporated within
legislation. BNM has indicated that proposed FSA aims to do this.

Suitability of
Persons

Legislative amendments should be made to require significant owners to
continually comply with suitability requirements, and provide substantive
powers to adequately address situations where significant owners no longer
meet such requirements. This is expected to be addressed in the proposed
FSA.

Changes in
Control and
Portfolio
Transfers

To ensure greater consistency of requirements and approval objectives, and
reduce the potential of undue political interference in transactions requiring
Ministerial approval, legislation should more explicitly define the approval
criteria for acquisitions of a significant ownership interests and portfolio
transfers. This is expected to be addressed in the proposed FSA.

Corporate
Governance

To ensure the continued appropriateness and clarity of its corporate
governance expectations, BNM should update and consolidate its related
guidelines where appropriate. In doing so, BNM should take into consideration
the recent updates made to the Malaysian Code on Corporate Governance,
by the SC, that are to be implemented beginning later this year by the
companies listed on Bursa Malaysia.

Risk
Management
and Internal
Controls

To ensure the continued appropriateness and clarity of its risk management
and internal control expectations for insurers, BNM should update its related
guidelines where appropriate.

9. Supervisory
Review and
Reporting

The finalization and implementation of BNM’s recent concept paper on risk
management governance, which BNM indicates would occur in late 2012,
should assist in addressing identified gaps.
BNM’s SuRF may not be appropriate for use on certain types of supervisory
reviews, Such concerns are outlined within the assessment of other ICPs.

36
Insurance Core
Principle
10. Enforcement

Recommendations
To enhance the structure and effectiveness of the enforcement regime,
consideration should be given to:
 Better aligning the need for Ministerial approval for enforcement actions
within legislation with clearer objectives and purpose for such powers;
 Enhancing the range and options of the enforcement tools available to
BNM, and the deterrence measures within legislation; and
 Making the criteria or basis for BNM’s enforcement decisions or actions
more transparent.
The above is expected to be addressed in the proposed FSA.

11. Winding-up and
Exit from the
Market

To ensure greater understanding and consistency in intervention and
resolution practices, consideration should be given to more clearly defining
‘non-viability’ triggers within legislation.

12. Reinsurance
and Other
Forms of Risk
Transfer

To ensure the continued appropriateness and sufficient scope of its
reinsurance management expectations for insurers, BNM should update and
expand its related guidelines where appropriate.

13. Valuation

BNM indicated that it plans to conduct more detailed assessments and
benchmarking of the methods used to for MOCE determination, so as to
strengthen processes, promote better comparability, and ensure regulatory
objectives are being met.
BNM should review the extent to which current valuation approaches for
solvency purposes adequately meet regulatory objectives during ‘normal’
stress periods, so that temporary adjustments to valuation approaches need
only be considered during truly anomalous economic conditions, such as
those existing around 2008-09.

14. Investment

BNM should review its investment related guidelines to identify and implement
further enhancements, which should include expectations on insurers’ use of
external credit ratings and investment aggregation risks on a group-wide level.

15. Enterprise Risk
Management for
Solvency
Purposes

BNM’s planned near-term changes will address many current gaps and
insurance sector inconsistencies within its enterprise risk management
expectations for insurers, particularly the implementation of its new ICAAP
requirements and its draft Risk Management Guidelines – Risk Governance.

16. Capital
Adequacy

BNM should give consideration to explicitly addressing interdependencies
between and within risk categories within the RBC framework. Also, for
greater clarity of RBC objectives, BNM should consider more explicitly
defining the RBC in terms of the level of risk protection that it should afford,
provided that BNM is satisfied that appropriate insurer competencies as well
as market depth and liquidity exist to support such an initiative.
In addition, to better promote prudent practices, BNM should establish
definitive project plans for the near term development and implementation of a
regulatory capital framework for financial guarantee insurance.

37
Insurance Core
Principle
17. Intermediaries

Recommendations
To substantively enhance the regulatory regime for insurance intermediaries,
legislative changes should be made to codify requirements for the
maintenance of separate fiduciary accounts for monies collected from clients
and to strengthen enforcement powers. This is expected to be addressed in
the proposed FSA.
Also, to ensure supervisory effectiveness, BNM should further develop a
supervisory approach more specific to the relevant considerations for
intermediaries.

18. Conduct of
Business

To enhance effectiveness, legislative amendments should be made to
strengthen enforcement powers and enhancements made to BNM’s market
conduct supervisory function and practices. This is expected to be addressed
in the proposed FSA.

19. Public
Disclosure

BNM should give consideration to enhancing its public disclosure regime for
insurers through additional requirements for disclosures of disaggregated
information on key measures such as insurer source of earnings and capital
adequacy measures and risks/risk management processes.

20. Countering
Fraud in
Insurance

BNM should give consideration to reviewing the effectiveness and rigour of
SuRF in adequately capturing and assessing insurer anti-fraud practices and
issues.

21. Anti-Money
Laundering and
Combating the
Financing of
Terrorism

BNM should utilize its FIU specialists on AML/CFT supervisory reviews of
insurers with significant sales of products having a higher susceptibility to
money laundering risks.

22. Group-wide
Supervision

Legislative amendments should be made to provide BNM with explicit powers
to regulate and supervise holding companies and related entities. The
proposed FSA is expected to explicitly empower BNM to regulate and
supervise holding companies and all its related entities

23. Macroprudential
Surveillance and
Insurance
Supervision

BNM utilizes macroprudential surveillance tools appropriate to the nature,
scale and complexity of the insurance sector. Enhancements could be made
by:

24. Supervisory
Cooperation and
Coordination



Requiring insurers to conduct periodic comprehensive industry-wide
standardized scenario testing exercises, this would provide BNM with an
additional tool for assessing the build-up of industry risks/ vulnerabilities;

Establishing a more structured internal processes for identifying,
assessing, monitoring and reporting on emerging risks in the industry;
and

Developing more robust indicators for assessing systemic risk of
insurers.
Recommendations on related matters of group-wide supervision and
information sharing considerations are addressed in assessments of other
ICPs.

38
Insurance Core
Principle

Recommendations

25. Cross-border
Cooperation and
Coordination on
Crisis
Management

BNM should further enhance its ability to contribute to the effective resolution
of a cross-border crisis by articulating its expectations of insurers to maintain:
 Comprehensive contingency plans; and
 Information systems capable of generating timely and reliable ad hoc
information on accumulation of risks.

F. Authorities’ Response to the Assessment
55.
Bank Negara Malaysia (the Bank) welcomes the assessment on Malaysia’s
observance of the Insurance Core Principles (ICPs). The assessment affirms the Bank’s
continuing efforts to maintain an effective regulatory and supervisory framework in ensuring
the safety and soundness of the insurance and takaful industry in Malaysia. The assessment
also makes recommendations that largely correspond with the Bank’s current priorities to
further strengthen the regulatory and supervisory system, and validates the various initiatives
that are at advanced stages of implementation or for which definite plans have been put in
place. We thank the assessors for the candid and open discussions, and the fruitful exchange
of views throughout the assessment process.
56.
A significant number of the recommendations will be addressed by the proposed
financial services legislation. Amongst others, this will provide greater transparency in
licensing standards and suitability requirements for shareholders. It will also further enhance
powers for the Bank to take timely enforcement and corrective actions, and provide for the
regulation and supervision of holding companies. Legislative changes and enhancements to
the supervisory framework will also strengthen market conduct standards across the industry,
including for intermediaries, and further reinforce financial integrity. The Bank’s policy
development framework, which was implemented in May 2012, will provide a well-defined
process for the development and communication of regulatory expectations going forward.
An important part of this process includes the regular review of regulatory standards issued
by the Bank to clarify, update and enhance the standards as necessary to reflect the changing
environment.
57.
In line with increasing regional and international financial integration, the Bank
is also committed to further strengthening its existing cooperation and exchange of
information arrangements with other supervisors and authorities, including through
wider participation in bilateral MOUs and by enhancing capabilities to support
effective cross-border crisis management and resolution. The Bank will also continue
with efforts to introduce more advanced tools for monitoring of systemic risks in the
insurance sector.

39
III. IOSCO OBJECTIVES AND PRINCIPLES OF SECURITIES REGULATION
A. Summary, Key Findings, and Recommendations7
58.
The Securities Commission Malaysia (SC), as the supervisor of the capital
markets, has developed a robust supervisory framework that exhibits high levels of
implementation of the International Organization of Securities Commissions Objectives
and Principles of Securities Regulation (IOSCO Principles) in most areas. The regimes
governing the regulation of issuers, auditors, collective investment schemes, market
intermediaries and secondary markets, and with respect to enforcement, co-operation and
information sharing, are extensive.
59.
There are, however, some areas where enhancements are advisable. The SC’s
independence would be buttressed by some changes to the legal provisions on removal of
commission members and to protections given to the members of the Commission and to its
staff. The disclosure deadlines for issuers and their substantial shareholders should be
adjusted to reflect international best practices. The new frameworks for oversight of credit
rating agencies and the Federation of Investment Managers Malaysia should be implemented
in full by carrying out on-site inspections as presently planned. At this stage in the
jurisdiction’s development, consideration should also be given to putting in place the preconditions that will enable the SC to ease up gradually on the intensity of its direct
involvement in the day-to-day operations of the capital market and its participants.
B. Institutional and Market Structure—Overview
60.
The Malaysian financial system is regulated by two main authorities: the SC and
BNM. Both report to the Minister of Finance. They have clearly delineated areas of oversight
and accountability set out in legislation. Formal arrangements govern areas of joint
responsibility, such as investment banks, and give the SC authority to approve capital
markets products designed, operated and offered by institutions licensed by BNM.
61.
The SC is a regulatory authority with broad powers to regulate the capital
markets in operation in Malaysia; its responsibilities, powers and authority with respect
to the capital market are established by statute.8 It has regulatory authority over equity
securities, debt securities and derivatives, whether traded over-the-counter (OTC) or on
organized markets, as well as other capital markets activities such as discretionary portfolio
management and the management of collective investment schemes (CIS—or unit trusts).
7

The assessment was conducted by Tanis MacLaren (consultant to the IMF) using the 2011 IOSCO
Methodology for Assessing Implementation of the IOSCO Principles (the Assessment Methodology).

SC draws its powers from several laws, including the Securities Commission Act 1993 (SCA), Capital
Markets and Services Act 2007 (CMSA) and Securities Industry (Central Depositories) Act 1991 (SICDA).

40
The SC has authority to make binding regulations, as well as issue guidelines and practice
notes on products and services offered in both the conventional and Islamic segments of the
capital market. The statutes have been supplemented with detailed secondary legislation in
almost every area of the SC's authority.
62.
BNM is the central bank and the supervisory authority for a broad array of
financial institutions operating in Malaysia. In addition to being the supervisor of the
banking and insurance sectors, BNM has oversight over the foreign exchange and money
markets. The BNM reports to the Finance Minister.
63.
The SC is led by a nine member Commission headed by an Executive Chairman.
The Commission meets monthly to deliberate on matters such as appeals and Commission
policies. Other than administrative and day-to-day matters, all functions of the SC, including
approvals associated with its gate-keeping authority and oversight of the capital market, are
vested with the Commission. Two affiliated agencies were established to complement SC’s
core functions: the Securities Industry Dispute Resolution Centre (SIDREC) and the
Securities Industry Development Corporation (SIDC).


SIDREC is a specialized dispute resolution body which facilitates prompt settlement
of claims against certain licensed market intermediaries. It provides dispute resolution
services for any dealing or transaction involving capital market products or services.
The process involves both mediation and, where necessary, adjudication by SIDREC.



The Audit Oversight Board (AOB) is part of the SC, but is governed by a separate
board made up of representatives from the accounting profession, regulators
including the SC, BNM and the Companies Commission Malaysia, and the private
sector. It provides independent audit oversight of public interest entities (PIEs).

64.
The SC currently is prescriptive in how it executes its mandates with respect to
regulating and developing the capital markets. The SC has been very involved in most
aspects of how the capital markets and their participants operate; and this risks leaving the
Malaysian markets somewhat constrained when they face competition in the region, both for
capital and market share. But the SC is starting to take a less prescriptive approach to
regulating and developing the market. It has issued two documents recently—the Capital
Market Masterplan 2 (CMMP2), which sets out SC’s strategic direction in structurally
reforming and developing the market, and the Corporate Governance Blueprint 2011.
CMMP2 was launched in 2011, with the theme ‘Growth with Governance’. The thrust is to
complement regulatory discipline with self- and market-discipline. Given these plans, the SC
appears to be giving due consideration to moving a less directive mode of regulation. For
example, it has a strategy in place to give more emphasis on disclosure and less emphasis on
merit reviews of new issues. These efforts should be encouraged.
65.
There is one securities exchange (Bursa Malaysia Securities) and one derivatives
exchange (Bursa Malaysia Derivatives) operating under authorization granted by the

41
Minister. Both, along with the securities and derivatives clearing houses, central securities
depository and the operator of an electronic trading platform for the trading and reporting of
bonds, are subsidiaries of the Bursa Malaysia Berhad holding company. The securities
exchange has two equity markets—the Main Market and the ACE Market (for companies
that have good growth potential but insufficient history to qualify for the Main Market).
Bond trading takes place OTC but trades must be reported for transparency purposes.
66.
The regulatory structure in Malaysia makes use of self-regulatory organizations
(SROs) that exercise some direct oversight responsibility for certain market
participants. Their rules are subject to meaningful sanctions. The two SROs are Bursa
Malaysia and the Federation of Investment Managers Malaysia (FIMM). FIMM is a
recognized and authorized SRO, responsible for the supervision of participants in the unit
trust market (including registration of distribution agents). Bursa Malaysia is recognized as
an exchange holding company, but undertakes certain functions of an SRO and is the front
line regulator of stockbrokers and futures brokers and participants in the clearing houses.
67.
There are two components to the capital markets in Malaysia, conventional and
Islamic; but the latter has not been assessed separately in this review. The Assessment
Methodology does not distinguish between conventional and Islamic markets with respect to
expectations or standards. In any event, owing to the way the two markets are regulated in
this jurisdiction, the ratings are equally applicable to both. The Islamic market operates
parallel to the conventional market. The fundamental securities regulatory scheme for each
market is similar, but with an additional set of requirements layered on top to ensure the
Islamic products and services are Shariah-compliant. SC is guided by the Shariah Advisory
Council (SAC), made up of Islamic finance and Shariah experts.
C. Preconditions for Effective Securities Regulation
68.
The preconditions for effective supervision (a stable macroeconomic
environment, sound legal and accounting framework, and effectiveness of procedures
for the efficient resolution of problems in the securities market) appear to be in place.
There are specialized courts with expertise to deal with complex commercial matters,
including capital markets transactions. The Companies Act contains comprehensive
provisions relating to the management of the company, rights of shareholders, duties of
directors and officers, preparation of company accounts and audit, issuance of shares and
debentures, proceeding of general meetings and the winding up of companies. If a company
is publicly listed, the CMSA and the Listing Requirements of the exchange prescribe
additional requirements. Take-overs and mergers are governed by the CMSA and the Code
on Take-overs and Mergers (the latter has statutory backing and is enforceable by the SC).
69.
The bankruptcy legislation is dated, but is under review and is expected to be
substantially amended in the near future. However, the CMSA provides for modifications
to the laws of insolvency and miscellaneous provisions in relation to the default procedures

42
of the clearing house. If any participant of Bursa Malaysia becomes insolvent, trades on the
securities and derivatives exchanges continue to be enforceable.
D. Main Findings
70.
Principles 1–8, relating to the regulator: The SC has clear statutory authority over
and responsibility for the Malaysian capital markets. In practice, the SC has operational
independence. Its independence at law is somewhat impaired as the Minister has the right to
dismiss any member of the Commission without cause at any time. The statutory immunity
of Commission members and staff members does not extend to cover former employees and
agents. Persons affected by decisions of the SC are afforded a full range of protections,
including the right to be heard, to written reasons and to rights of appeal. The SC's staff are
subject to detailed conduct rules. The SC has an explicit mandate and authority for
monitoring, mitigating and managing systemic risk. Regulatory processes are in place to
carry out this mandate and communication and information sharing between SC and BNM.
The perimeter of regulation is assessed regularly; where developments in the market require
action, the SC can exercise its public interest jurisdiction to block problematic behavior or
products or change the relevant rules to permit new services and products. The SC, issuers,
intermediaries, credit rating agencies (CRAs) the Bursa, FIMM and CIS are subject to
extensive requirements regarding the management and disclosure of conflicts of interest.
71.
Principle 9, relating to self-regulation: The two SROs, Bursa Malaysia and FIMM,
are subject to the oversight of the SC and are required to observe high standards of conduct.
The regime applicable to Bursa Malaysia is detailed, comprehensive and has been operating
effectively for several years. The SC has recently established the supervisory framework for
FIMM as an SRO. As at the date of the review, the SC had not yet conducted an on-site
examination of FIMM, though other modes of oversight were operative.9
72.
Principles 10–12, relating to enforcement of securities regulation: The SC has
broad inspection, investigation and surveillance powers; and can investigate and take action
against anyone who breaches the laws it administers. The SC carries on active inspection and
enforcement programs. Both on-site and off-site reviews of regulated entities are performed.
73.
Principles 13–15, for cooperation in regulation: The SC has the ability and
capacity to share information and cooperate with regulators, both domestically and
internationally. There is no requirement that there be an MOU in place. The SC has specific
authority to provide assistance to a foreign supervisory authority to investigate an alleged
breach of a legal or regulatory requirement. The SC is a signatory to the IOSCO Multilateral
MOU and to many bilateral MOUs with its counterparts in other countries.

An on-site inspection of FIMM has since been carried out.

43
74.
Principles 16–18, for issuers: Extensive requirements are in place for initial offering
and continuous disclosure documents for securities. New issues of securities to the public
must have prospectuses registered by the SC. Virtually all public issues of equity securities
are listed on the Bursa and subject to the CMSA, SC guidelines and the Listing
Requirements. Continuing disclosure documents are made public through the Bursa.
Investors are treated equitably with respect to voting, access to information and the ability to
participate in any takeover bid. As of January 2012, Malaysia implemented International
Financial Reporting Standards (IFRS) for all PIEs, which includes public companies, CIS,
financial institutions and market intermediaries. The publication of annual audited financial
statements and annual reports by listed companies is slow compared to the requirements that
apply to CIS. The notice period for shareholder meetings may be too short for full
communication with all shareholders. Substantial shareholders in listed companies are given
much longer to report their initial positions and any changes than are the directors and the
CEOs of these issuers. The definition of 'interests in securities' does not include publicly
offered rights. There is no timely public transparency of information on the positions of these
key personnel for unlisted public companies.
75.
Principles 19–23, for auditors, credit rating agencies and other information
service providers: Auditors of PIEs are subject to appropriate levels of oversight, and must
be registered with the AOB. There are extensive requirements for auditors to be independent
of the entities they audit and these requirements are enforced by the AOB. The regulatory
framework in Malaysia requires that the financial statements included in public offering and
listing particulars documents and publicly available annual reports be audited in accordance
with the International Standards on Auditing, for all periods beginning on or after January 1,
2010. CRAs whose ratings are used for regulatory purposes are subject to registration; bonds
issued in ringgit must be rated. The SC has full power to supervise these entities. The SC has
a framework in place to conduct on-site examinations of CRAs. As of the date of the review,
SC had yet to conduct an on-site examination of a CRA (one has since been completed).
Investment advisors/analysts, corporate finance advisors and bond pricing agencies have to
be licensed or registered with the SC.
76.
Principles 24–28, for collective investment schemes and hedge funds: All publicly
offered CIS and their operators and distributors are subject to authorization and reporting
requirements. All funds offered to the public must be approved by the SC: this includes the
review of a prospectus that contains comprehensive and timely information. Funds are
established as unit trusts, with assets segregated from those of the operator and distributor
and held by an independent trustee approved by the SC. All CIS and their operators and
distributors are subject to a comprehensive supervision framework that includes both off-site
and on-site reviews. The fund’s securities and its assets are subject to valuation in accordance
with IFRS. Continuous disclosure of unit prices is provided through the FIMM website. A
hedge fund can be set up under the wholesale framework to offer securities only to qualified
(sophisticated) investors and must be approved by the SC. Wholesale funds are also subject

44
to requirements to report regularly to investors and to the SC, including delivery of audited
annual reports within two months of the fund's year end.
77.
Principles 29–32, for market intermediaries: A framework is in place for licensing
and to apply on-going requirements for market intermediaries. Applicants are subject to
detailed reviews before being licensed. There are initial and ongoing capital requirements for
all types of intermediaries that reflect the risks undertaken. The capital requirements for
stock-broking and futures broking companies address the full range of risks, including
market, credit, liquidity and operational risk. There are requirements regarding immediate
reporting of deficiencies. Market intermediaries are required to have extensive systems of
risk management and internal controls in place. There are regulations for protection of
clients, including segregation of clients’ assets and business conduct rules. The SC plans for
dealing with a firm’s failure include action to restrain conduct, to ensure client’s assets are
properly managed and to provide relevant information to the regulators and the general
public.
78.
Principles 33–37, for the secondary markets: Exchanges are subject to
authorization by the Minister with the advice of the SC. The monitoring activities conducted
by Bursa Malaysia include conducting real-time surveillance of the market and supervision
of its participating members and clearing members. Market surveillance for trading on the
securities market is performed at the exchange and the SC in parallel. The SC has a
comprehensive oversight system for exchange supervision that includes on-site examinations
and off-site reviews of rules and other matters. The SC may suspend the operations of a stock
exchange or Registered Electronic Facility (REF). On the recommendation of the SC, the
Minister may revoke the authorization of any exchange; the SC may revoke an REF’s
registration. There is both pre-trade and post-trade real-time transparency of prices on the
Bursa exchanges, other than for certain specified trades subject to clearly defined conditions.
The rules against market abusive transactions are extensive and there are mechanisms to
detect and take action against improper conduct. Trades on both the securities and derivatives
exchanges are cleared and settled through central counterparties that have detailed and
transparent provisions designed to protect the markets against a default by any participant.

45
Table 5. Summary Implementation of the IOSCO Principles—Detailed Assessments
Principle
1. The responsibilities of
the Regulator should be
clear and objectively
stated.

2. The Regulator should
be operationally
independent and
accountable in the
exercise of its functions
and powers.
3. The Regulator should
have adequate powers,
proper resources and the
capacity to perform its
functions and exercise its
powers.

4. The Regulator should
adopt clear and
consistent regulatory
processes.

5. The staff of the
Regulator should observe
the highest professional
standards, including
appropriate standards of
confidentiality.
6. The Regulator should
have or contribute to a
process to monitor,
mitigate and manage
systemic risk, appropriate
to its mandate.

Findings
The SC has clear statutory authority over and responsibility for the
Malaysian capital markets. Where there are overlaps between the SC
and BNM with respect to market participants, the securities legislation is
designed to minimize regulatory differences or gaps. There are
arrangements in place between the two authorities to support equivalent
protections for investors and to coordinate regulatory activities.
The SC in practice has a high degree of independence from the
government and industry and its internal processes and governance
reinforce that independence. However, there are gaps in the provisions
of the law that support independence of action by the Commission
members and staff that need to be addressed. Persons affected by
decisions of the SC are afforded a full range of protections, including the
right to be heard, to written reasons and to rights of appeal.
The SC has sufficient powers to carry out its functions under the
securities laws. The SC responsibilities, powers and authorities are set
out in securities laws. It has full authority to license, inspect, enforce and
regulate the participants in the capital market in Malaysia. It has the
statutory power to make legally enforceable regulations and guidelines.
The SC’s funding is adequate to permit it to fulfill its responsibilities. The
SC has policies and governance practices in place to guide the
performance of its functions and exercise of its powers. The SC places a
significant emphasis on investor education as a key component of its
investor protection mandate.
There are processes and procedures adopted within the SC to ensure
that regulatory actions undertaken by the SC are fair and reasonable,
transparent and comprehensible to the affected persons and the
marketplace, and that there is consistent application of relevant
principles. There is a notable level of transparency in how the SC
operates and all laws, regulations, guidelines etc. are available on the
website. Persons affected by decisions of the SC are afforded a full
range of protections, including the right to be heard, to written reasons
and to rights of appeal.
SC staff observe high standards of professional conduct and are subject
to detailed ethical and conduct rules. Any violation or infringement of
provisions of any applicable law, the Code of Conduct, the Terms and
Conditions of Employment and any conduct on the part of the staff
member that is inconsistent with the faithful discharge of duties towards
the SC would be construed as misconduct. Misconduct may result in the
institution of disciplinary proceedings.
The SC has an explicit mandate and authority for monitoring, mitigating
and managing systemic risk. There are regulatory processes in place to
carry out this mandate and communication and information sharing
between the Commission and BNM. It is invited to participate in
meetings of the Financial Stability Executive Committee (FSEC) only
when capital markets issues have been identified as a topic of
discussion.

46
Principle
7. The Regulator should
have or contribute to a
process to review the
perimeter of regulation
regularly.

8. The Regulator should
seek to ensure that
conflicts of interest and
misalignment of
incentives are avoided,
eliminated, disclosed or
otherwise managed.
9. Where the regulatory
system makes use of
Self-Regulatory
Organizations (SROs)
that exercise some direct
oversight responsibility for
their respective areas of
competence, such SROs
should be subject to the
oversight of the Regulator
and should observe
standards of fairness and
confidentiality when
exercising powers and
delegated responsibilities.

10. The Regulator should
have comprehensive
inspection, investigation
and surveillance powers.
11. The Regulator should
have comprehensive
enforcement powers.
12. The regulatory system
should ensure an
effective and credible use
of inspection,
investigation, surveillance
and enforcement powers
and implementation of an
effective compliance
program.

Findings
The perimeter of regulation is assessed regularly and where
developments in the market require action, the SC can take action. If the
developments are of concern, it may exercise its public interest
jurisdiction to block problematic behaviour or products. If the existing
rules are blocking positive developments, such as new services and
products, the guidelines and rules may be changed. The SC has good
access to the legislative agenda where changes to the law are required.
The SC has processes in place to address conflicts of interest and
misalignment of incentives. The SC staff, issuers, intermediaries, the
Bursa, FIMM, CRAs and CIS are subject to extensive requirements
regarding the avoidance, mitigation, management and disclosure of
conflicts of interest.

There are two organizations in the Malaysian capital markets that
exercise some direct oversight responsibility for certain markets and
market participants. Both Bursa Malaysia and FIMM are subject to the
oversight of the SC and are required to observe high standards of
conduct in carrying out their tasks. The regime applicable to Bursa
Malaysia is detailed, comprehensive and has been operating effectively
for many years. FIMM, for many years, has had a quasi-regulatory role
with respect to supervision of unit trust marketing and distribution
activities, largely with respect to individual sales personnel and has been
subject to the supervision of the SC in that regard. It was recognized as
an SRO in January of 2011 after a full application process and review
and is subject to extensive reporting requirements under the law and its
conditions of recognition. The supervisory framework for FIMM includes
on- and off-site supervision, reporting and a rule review process. While
the first on-site regulatory examination is scheduled to take place in the
next quarter, there is evidence that the SC takes action where issues are
identified from reports filed, complaints or from other sources. Note that
the first on-site inspection of FIMM was carried out in May, 2012. The SC
retains full authority to oversee Bursa Malaysia and FIMM members and
registrants.
The SC has broad inspection, investigation and surveillance powers.

The SC has broad powers to investigate and take action against anyone
who breaches the laws it administers.
Both on-site and off-site reviews of regulated entities are performed by
the SC. Bursa Malaysia performs on and off-site reviews of its participant
firms. Market surveillance is performed at the exchanges and at the SC.
The SC and Bursa Malaysia conduct reviews of continuing disclosure
information provided by listed companies. Market intermediaries must
have effective compliance systems.

47
Principle
13. The Regulator should
have authority to share
both public and nonpublic information with
domestic and foreign
counterparts.
14. Regulators should
establish information
sharing mechanisms that
set out when and how
they will share both public
and non-public
information with their
domestic and foreign
counterparts.
15. The regulatory system
should allow for
assistance to be provided
to foreign Regulators who
need to make inquiries in
the discharge of their
functions and exercise of
their powers.
16. There should be full,
accurate and timely
disclosure of financial
results, risk and other
information that is
material to investors’
decisions.

17. Holders of securities
in a company should be
treated in a fair and
equitable manner.

Findings
The SC has the ability and capacity to share information and cooperate
with regulators, both domestically and internationally. It can share
confidential information with any other foreign regulatory authority and
has a record of active cooperation.

The SC is a signatory to the IOSCO Multilateral MOU and to many
bilateral MOUs with its counterparties in other jurisdictions.

The SC may provide extensive assistance to foreign regulatory
authorities in carrying out their responsibilities, including by obtaining
and sharing information and cooperating on inspections. The SC does
not require the permission of any outside authority to share information
and an independent interest or dual illegality is not required as a
precondition to cooperation.

Extensive requirements are in place for offering and continuous
disclosure documents for securities. The disclosure to be provided to
futures contract purchasers is specified under the law and the rules of
the Bursa Malaysia Derivatives. New issues of securities (debt, equity or
collective investment schemes) to the public are required to be offered
via prospectus that must be registered by the SC. Virtually all public
issues of equity securities are listed on the Bursa Malaysia and are
subject to the provisions in the Listing Requirements. The SC approves
listings on the Main Market of Bursa Malaysia and the Bursa approves
listings on the ACE Market. Continuous disclosure documents are made
public through the facilities of the exchange. The publication deadlines
for annual reports and audited financial statements by public companies
are long compared to international standards and very long when
compared to the reporting period required for CIS in the jurisdiction.
Investors are treated equitably with respect to voting, access to
information and the ability to participate in any takeover bid. Full
information must be provided for any takeover bid. The notice period for
shareholder meetings is fairly short and there are limitations in the
corporate law in the use of proxies that may hamper fully effective
exercise of shareholders' voting rights. Substantial shareholders in listed
companies are given much longer to report their initial positions and any
changes than are the directors and CEOs of these issuers. Other
members of the senior management have very limited disclosure
obligations. The definition of 'interests in securities' does not include
publicly offered rights. There is no timely public transparency of
information on the positions of these key personnel for unlisted public
companies.

48
Principle
18. Accounting standards
used by issuers to
prepare financial
statements should be of a
high and internationally
acceptable quality.
19. Auditors should be
subject to adequate levels
of oversight.

20. Auditors should be
independent of the
issuing entity that they
audit.
21. Audit standards
should be of a high and
internationally acceptable
quality.
22. Credit rating agencies
should be subject to
adequate levels of
oversight. The regulatory
system should ensure
that credit rating agencies
whose ratings are used
for regulatory purposes
are subject to registration
and on-going supervision.

23. Other entities that
offer investors analytical
or evaluative services
should be subject to
oversight and regulation
appropriate to the impact
their activities have on the
market or the degree to
which the regulatory
system relies on them.
24. The regulatory system
should set standards for
the eligibility, governance,
organization and
operational conduct of
those who wish to market
or operate a collective
investment scheme.

Findings
All Public Interest Entities (PIEs), which include public companies,
collective investment schemes, financial institutions and market
intermediaries are required to prepare their financial statements using
International Financial Reporting Standards (IFRS).

There is a system in place in Malaysia that subjects auditors of PIEs to
appropriate levels of oversight. Auditors of PIEs must be registered with
the Audit Oversight Board (AOB), which is a business group of the SC.
The AOB conducts examinations of auditors and has the power to
sanction breaches of the standards.
There are extensive requirements for auditors to be independent of the
entities they audit and these requirements are enforced by the AOB.

The financial statements included in prospectuses, listing documents
and publicly available annual reports must be audited in accordance with
the International Standards on Auditing issued by the International
Federation of Accountants.
Credit rating agencies (CRAs) whose ratings are used for regulatory
purposes are subject to registration; bonds issued in ringgit must be
rated. The SC has full power to supervise these entities, including the
power to carry out on-site and off-site examinations and sanctioning. The
SC has had a supervisory framework in place for these agencies since
2006 that included off-site review and engagement with management
where deficiencies were noted. At the time of the review, while the SC
had yet to conduct an on-site examination of a CRA, there is evidence of
active and extensive review of the activities of the CRAs and
investigation into any problematic issues identified. An on-site inspection
of one of the two domestic CRAs was carried out, beginning in the first
week of May 2012, and has since been completed.
Entities that provide analytical or evaluative services include investment
advisors/analysts, corporate finance advisors, bond pricing agencies and
property valuers. Investment advisors/analysts, corporate finance
advisors and bond pricing agencies have to be licensed or registered
with the SC. Property valuers are professionals registered with the Board
of Valuers under the purview of the Ministry of Finance.

All CIS offered to the public and their operators and distributors are
subject to authorization and reporting requirements. The requirements
for licensing by the SC require the operator and fund manager (portfolio
manager) to have in place appropriate organizational and operational
structures, including risk management systems and internal controls. All
CIS and their operators and distributors are subject to a comprehensive
supervision framework that includes both off-site and on-site reviews.
Outsourcing is permitted for some activities but is subject to detailed
requirements.

49
Principle
25. The regulatory system
should provide for rules
governing the legal form
and structure of collective
investment schemes and
the segregation and
protection of client assets.
26. Regulation should
require disclosure, as set
forth under the principles
for issuers, which is
necessary to evaluate the
suitability of a collective
investment scheme for a
particular investor and the
value of the investor’s
interest in the scheme.
27. Regulation should
ensure that there is a
proper and disclosed
basis for asset valuation
and the pricing and the
redemption of units in a
collective investment
scheme.
Principle 28. Regulation
should ensure that hedge
funds and/or hedge funds
managers/advisers are
subject to appropriate
oversight.

29. Regulation should
provide for minimum entry
standards for market
intermediaries.

30. There should be initial
and on-going capital and
other prudential

Findings
Funds are established as unit trusts, with assets segregated from those
of the operator and distributor and held by an independent trustee that
must be approved by the SC.

All funds offered to the public must be approved by the SC, which
process includes the review of a detailed prospectus that contains
comprehensive and timely information about the CIS. Material changes
require prompt notice and usually the amendment of the prospectus.
Prospectus amendments are subject to review by the SC prior to
registration.

The fund’s securities and its assets are subject to valuation in
accordance with IFRS. Continuous disclosure of unit prices is provided
through the FIMM website. The prospectus of the fund must contain
information about valuation, pricing and the applicable provisions
governing purchase and redemption of funds.

There is no special definition of hedge fund in the jurisdiction. CIS,
including hedge funds, can be set up under a clearly defined wholesale
framework to offer securities only to qualified (sophisticated) investors.
These funds must be approved by the SC. The operator must be
licensed by the SC as a fund management company and are subject to
inspection under the risk-based supervision program that applies to all
market intermediaries. The offering memorandum containing specified
information about the fund must be deposited with the SC. These
wholesale funds are required to provide regular reporting to their
investors and to the SC, including preparing annual audited reports
within two months of year end.
A framework is in place for licensing and to apply on-going requirements
for market intermediaries. Applicants are subject to detailed off-site
reviews before being licensed. All firms that are applying to be Bursa
Malaysia participants are subject to extensive on-site readiness
assessments of their operations and systems by Bursa Malaysia before
they are approved. For FMCs, the SC does an on-site check once
business has commenced to ensure operations are functioning as
required. Certain other licensees are subject to requirements for external
audits after beginning operations to confirm systems are effective.
There are initial and ongoing capital requirements for all types of
intermediaries to ensure that they have adequate resources to meet their
business commitments and address the risks of their businesses. The

50
Principle
requirements for market
intermediaries that reflect
the risks that the
intermediaries undertake.

31. Market intermediaries
should be required to
establish an internal
function that delivers
compliance with
standards for internal
organization and
operational conduct, with
the aim of protecting the
interests of clients and
their assets and ensuring
proper management of
risk, through which
management of the
intermediary accepts
primary responsibility for
these matters.
32. There should be
procedures for dealing
with the failure of a
market intermediary in
order to minimize damage
and loss to investors and
to contain systemic risk.
33. The establishment of
trading systems including
securities exchanges
should be subject to
regulatory authorization
and oversight.
34. There should be ongoing regulatory
supervision of exchanges
and trading systems that
should aim to ensure that
the integrity of trading is
maintained through fair
and equitable rules that
strike an appropriate

Findings
capital requirements for stockbroking and futures broking companies
specifically address the full range of risks to which the firms are exposed,
including market, credit, liquidity and operational risk. The capital
formulae for other intermediaries are fairly simple, reflecting the nature of
their operations that are carried on in practice. FMCs are permitted to
carry on proprietary trading but a large majority of the positions held
raise few risks and the activity is subject to extensive monitoring by the
SC. There are requirements regarding capital calculations and
immediate reporting of deficiencies by market intermediaries.
Market intermediaries are required to have extensive systems of risk
management and internal controls in place. The firm’s internal audit
function must review these systems annually and the results of that
review must be reported to the Board of Directors of the firm. There are
regulations for proper protection of clients, including requirements for
segregation of clients’ assets and business conduct rules, such as ‘know
your client’ and suitability. The rules regarding conflicts of interest are
extensive.

The SC has plans in place for dealing with a firm’s failure. The plans are
flexible to include action to restrain conduct, to ensure clients’ assets are
properly managed and to provide relevant information to the regulators
and the general public. There are investor compensation funds available
in the event of losses. Where a failure has cross border implications,
MOUs are in place to facilitate information sharing.
Exchanges are subject to authorization by the Minister with the advice of
the SC. An electronic facility, which falls within the meaning of “stock
market” but is not intended to operate as a stock exchange or derivatives
exchange, must be registered by the SC as a Registered Electronic
Facility (REF). There are specified criteria that any applicant must meet,
including requirements regarding systems and other infrastructure
capacity, technical competence etc.
The SC has a comprehensive oversight system for exchange
supervision that includes on-site examinations and off-site reviews of
rules and other matters. The SC may suspend the operations of a stock
exchange or REF. On the recommendation of the SC, the Minister may
revoke the authorization of any exchange; the SC may revoke an REF’s
registration. Surveillance of the markets is carried on by the exchanges
and SC.

51
Principle
balance between the
demands of different
market participants.
35. Regulation should
promote transparency of
trading.

36. Regulation should be
designed to detect and
deter manipulation and
other unfair trading
practices.
37. Regulation should aim
to ensure the proper
management of large
exposures, default risk
and market disruption.

38. Securities settlement
systems and central
counterparties should be
subject to regulatory and
supervisory requirements
that are designed to
ensure that they are fair,
effective and efficient and
that they reduce systemic
risk.

Findings

There is both pre-trade and post-trade real-time transparency of prices
on the Bursa Malaysia exchanges for most trades, Certain specified
trades (Direct Business Transactions) are permitted to take place outside
the automatic trading system, subject to clearly defined conditions and
prompt post-trade reporting. There are no dark pools operating in
Malaysia.
The rules against market abusive transactions are extensive and there
are mechanisms in place to detect and take action against improper
conduct. Both the SC and the Bursa collect and analyze extensive
trading data to deter and detect improper transactions.
Trades on both the securities and derivatives exchanges are cleared and
settled through central clearing houses that have detailed and
transparent provisions designed to protect the markets against a default
by any participant. There are regular consultations and sharing of
information between Bursa Malaysia and the SC. There are also both
formal and informal arrangements in place to enable SC and BNM to
consult each other in order to minimize the adverse effects of market
disruptions.
Not assessed

E. Summary Implementation and Recommended Action Plan
Table 6. Recommended Action Plan to Improve Implementation of the IOSCO
Principles
Principle
Principle 1

Recommended Action
The authorities should be encouraged to continue to work jointly to ensure
consistency in the standards of disclosure and market conduct and in the
supervision of the market participants, in order to provide Malaysian investors
with an appropriate level of investor protection, regardless of which investment
product or service they acquire or intermediary from which they acquire it.

52
Principle
Principle 2

Recommended Action
The SCA should be amended to include general qualification requirements for
Commission members, state that a Commission member may only be removed
from his/her office for cause and delineate those causes, such as bankruptcy,
persistent failure to attend meetings, acting in conflict of interest, etc. The right of
the Minister to remove members at any time should be repealed.
Consideration should be given to extending the statutory immunity provisions in
the SCA to persons who were acting on behalf of the SC at the time of the actions
in question. Coverage should not depend on the person’s employment status at
the time of the lawsuit; former employees and agents should be included.
Further, consideration should be given to including provisions permitting the SC to
indemnify these persons for their legal costs in the event they are sued.

Principle 6

As the SC has an explicit mandate and authority for monitoring, mitigating and
managing systemic risk, consideration should be given to making the SC a
permanent member of the Financial Stability Executive Committee.

Principle 9

The first regulatory audit of FIMM by the SC should take place as soon as
practicable.
(Note that the regulatory audit of FIMM was conducted by the SC in May 2012.)

Principles 11
and 12

Consideration should be given to conducting an examination of the adequacy
(and the consistency) of maximum fines that may be imposed under the
legislation to ensure these amounts are high enough, given the growth in the
market and its profitability. In any event, the fines that can be imposed by the SC
should not be less than those that may be imposed by the Bursa.

Principle 16

The SC’s Corporate Governance Blueprint 2011 recommends a taskforce of
industry and regulators to be formed to review the current framework for periodic
disclosure of financial and non-financial information, including the shortening of
the submission period for quarterly and annual reports. This should be pursued.
In particular, consideration should be given to requiring the audited annual
financial statements to be published within 90 days of the year-end, with the
annual report available promptly thereafter.
The SC should consider recommending the CMSA be amended to provide for
civil liability for misstatements in continuous disclosure documents in the same
way this liability applies to misstatements in prospectuses and other offering
documents. Actions on these civil liability claims can be made simpler by
including a provision that anyone who purchased the security affected by the
misstatement is deemed to have relied on that misstatement.

Principle 17

The SC’s Corporate Governance Blueprint contains recommendations that
encourage:




Companies to voluntarily extend the notice period for
shareholder meetings to ensure investors have sufficient time to
make fully informed decisions about the matters to be discussed
at a meeting and to return their voting instructions in time; and
The elimination of the restrictions in Section 149 of the
Companies Act that limit who may be appointed as proxy and the
actions the proxy may take.

53
Principle

Recommended Action
These changes should be pursued to ensure all shareholders have the
information in time to make informed voting decisions and can execute them
effectively. The proxy limitations have been addressed in the Listing
Requirements, however, consideration should be given to making these
mandatory requirements for all public companies.
Consideration should be given to aligning the requirements governing reporting
interests in the securities of issuers held by substantial shareholders, officers and
directors. The shorter time period that currently applies to the CEO and directors
of listed companies under the CMSA should be applicable to all of the substantial
shareholders, directors and all senior management of the issuers. The
requirements should apply to all public companies. Consideration should be
given to making this information for non-listed companies available to the public
on the SC's website.
Consideration should be given to widening the definition of what must be
disclosed (by both substantial shareholders, directors and officers) to include
public rights offerings that are presently excluded by the CMSA and the
Companies Act.

Principle 22

The first inspection of a CRA should take place as soon as practicable.
(Note that an on-site inspection of one of the two CRAs took place shortly after
the FSAP assessment visit was completed.)

Principle 30

In the longer term, consideration might be given to re-examining the capital
requirements for FMCs and moving to a risk-based formula that is more sensitive
to the risks of the specific positions held.

Principle 31

The Malaysian regulatory framework requires a market intermediary to be subject
to a periodic evaluation of its internal controls and risk management processes.
The firm’s internal auditor may conduct this review. Consideration should be
given to requiring external auditors do these assessments, at least for the stock
brokers and futures brokers that are members of Bursa Malaysia.

F. Authorities’ Response to the Assessment
79.
The high level of compliance accorded to the Malaysian capital market in this
assessment under the more rigorous IOSCO standards and the new Financial Market
Infrastructures (FMI) principles demonstrates that the strategic ‘roadmap’ adopted by the SC
in regulating and developing the market has been appropriate.
80.
Since its establishment, SC has been committed to benchmarking itself against
international standards and best practices. In the past, prevailing market conditions led
the SC to implement a prescribed approach to regulation which was appropriate and effective
under the circumstances. The SC has instituted a comprehensive regulatory and supervisory
framework, including the issuance of detailed laws and guidelines. This approach has
effectively enabled the SC to heighten transparency and establish clarity on the roles and

54
responsibilities of market participants, thus promoting stability and confidence in the
Malaysian capital market.
81.
These strategies were documented in the first Capital Market Masterplan
(CMP1), and recommendations were implemented between 2001 and 2010. These
measures, including market developmental initiatives, fostered stability and resilience which
helped to insulate the Malaysian capital market from the impact of the recent global financial
crisis. There is now a strong foundation for on-going efforts to develop the capital market
within a robust regulatory and supervisory structure, underpinned by a mandate to ensure
investor protection and reduce systemic risk. The IOSCO assessment result, as well as the
Malaysian capital market’s successful weathering of the recent GFC, is a validation of the
regulatory philosophy that is being adopted.
82.
The capital market has expanded significantly and become an important source
of financing in the Malaysian economy, particularly with the development of the bond
market to meet long-term financing needs. The capital market continues to evolve in
support of Malaysia’s economic transformation agenda. The resilience of the market now
gives SC the flexibility to adopt a regulatory framework that can drive greater competition
and innovation. Under the CMP2, the SC will adopt a regulatory approach that will further
drive market growth domestically and through greater internationalisation, while focusing on
strong governance arrangements, and streamlining regulatory procedures and processes.
83.
Malaysia is taking continuous steps to align its regulatory framework with the
changing global regulatory landscape and is actively involved in international financial
regulatory policymaking work.10 Amid the growing regional expansion of local market
intermediaries and plans to further internationalize the Malaysian capital market, the SC also
recognises the increasing importance of cross-border enforcement and supervisory
cooperation.
84.
While SC continuously reviews its policies to ensure that regulatory and
supervisory requirements remain relevant and effective, it welcomes suggestions by
multilateral institutions like the IMF and the World Bank, and pro-actively learns from
international best practices for putting in place appropriate preconditions that will be
essential to ensure an effective regulatory regime.
85.
The SC notes that a number of recommendations in the IOSCO DAR reflect
strategies identified in CMP2 as well as the CG Blueprint. Consequently, the SC is
already in the process of implementing the recommendations in this Report.

The SC Chairman is a member of the IOSCO Board and Vice-Chairman of the Emerging Markets
Committee. The SC is also involved in several regulatory policy committees of IOSCO.

55
86.
This Report noted that, as a self-funding statutory body with comprehensive
rules of internal governance, SC is operationally independent. The Report also noted that,
in practice, any discretionary power of the Minister provided by the securities law has always
been exercised upon advice and recommendation by the SC. The ability of the SC to promote
a sound and transparent capital market that supports economic growth has resulted in
building market confidence. The SC works closely with other regulators to ensure financial
stability while encouraging the development of new market segments and entry of new
players to promote competition. The overall stability of the capital market, amidst rapid but
orderly growth, has also meant that SC is trusted by the market and the government to
perform its functions effectively within its current governance structure.
87.
Issues raised in this Report on further enhancing information disclosure
practices by issuers and treatment of securities holders have already been identified in
the CG Blueprint, published prior to this assessment. Resolving these issues is a priority
for the SC and is part of its on-going efforts to heighten the quality of corporate governance
in Malaysia. These include the formation of a taskforce to review the current framework for
periodic disclosure by issuers (including the need to shorten the submission period for
quarterly and annual reports); a proposed extension of the notice period for shareholder
meetings to ensure effective and informed investor participation; and the removal of
restrictions on proxy voting. As of 3 January 2012, the Bursa Malaysia Listing Requirements
no longer have qualification restrictions for proxies and allow shareholders of listed
companies to appoint multiple proxies.
88.
The SC would like to thank the IOSCO assessors for their time and effort in
engaging with the SC staff, other authorities, market institutions and intermediaries,
and other stakeholders. While the assessment required significant resources and time, it has
been valuable in enabling the SC to identify its strengths as well as areas for further
improvement. The IOSCO assessment methodology is a useful tool for reviewing of the
effectiveness of regulatory and supervisory frameworks. The analysis and recommendations
contained in this Report will feed into SC’s on-going improvement efforts, with the aim of
effectively supporting the projected growth and greater internationalization in the capital
market during the CMP2 period.

56
IV. CORE PRINCIPLES FOR EFFECTIVE DEPOSIT INSURANCE SYSTEMS (IADI)
A. Methodology Used for the Assessment
89.
The evaluation of the compliance with the Core Principles for Effective Deposit
Insurance Systems was conducted on the Malaysia Deposit Insurance Corporation
(Perbadanan Insurans Deposit Malaysia or PIDM) utilizing the Methodology for
Compliance Assessment adopted in December 2010 by the Bank for International
Settlements and the International Association of Deposit Insurers.11 The Assessment
addresses PIDM’s compliance with the Core Principles solely with respect to its operations
as an insurer of deposits in commercial banks. In accordance with the Methodology, the
Assessment is designed to assess to the extent possible whether the criteria are fulfilled in
practice and not just in theory.
90.
The assessment was based on a review of relevant laws, regulations and
regulatory and supervisory practices related to the conventional banking sector and the
operations of PIDM. PIDM is an operationally independent deposit insurance agency
reporting to Parliament through the Minister of Finance. PIDM completed a self-assessment
in preparation for the FSAP and conducted a Workshop using the Core Principles
Methodology to assist in the FSAP review.
91.
There has been no experience with bank failures in Malaysia since PIDM’s
establishment in 2005. As a result the Assessment looked at the relevant provisions of the
legal framework without consideration of how the laws had been applied in practice or
interpreted by the courts. Several weaknesses in the legal framework have been noted in this
Assessment.
B. General Preconditions for an Effective Deposit Insurance System
Sound Governance of Agencies Comprising the Financial Safety Net
92.
BNM assumes responsibility for addressing financial stability concerns given its
mandate, powers and responsibilities and its role as the central bank and supervisory
authority for the banking and insurance sectors. Within BNM there is a Financial
Stability Committee which serves as BNM’s internal forum for discussing risks to financial
stability and deciding on the appropriate policy responses. It is at this Committee that a
decision would be made as to the non-viability of an institution, including member
institutions of PIDM.

This assessment was conducted by Claire McGuire, Senior Financial Sector Specialist with the World Bank.

57
93.
BNM also has a Financial Stability Executive Committee (FSEC) established in
2010 under Section 37 of its Act which considers proposals related to its various powers.
These powers include the issuance of orders or provision of liquidity assistance to persons or
financial institutions which it does not supervise, the purchase of shares or other capital
instruments or businesses or assets of a financial institution or the vesting of the business,
assets or liabilities of a financial institution in BNM, a corporation established by BNM or
another financial institution or other person. Two executive members from BNM and four
other members (Ministry of Finance, PIDM, an accountant and a lawyer) make up the FSEC.
The private sector members of the FSEC are subject to a Code of Ethics and Conflict of
Interest; they are also required to submit annual declarations of compliance with the Code
and filings of assets and exposures.
94.
BNM is empowered to enter into arrangements with other supervisory
authorities to coordinate financial stability measures. BNM engages with the Securities
Commission Malaysia and PIDM on a regular basis; the Governor of BNM sits on PIDM’s
Board. BNM coordinates with both agencies in the area of surveillance and supervision to
facilitate the timely identification of pre-emptive responses to systemic risk.
C. Well-Developed Legal Framework
95.
The legal system is well-developed with clear property rights. The judiciary in
Malaysia is independent, professional and benefits from protection of tenure and of an
adequate remuneration system. The effective operation of the insolvency and creditor rights
framework relies, to a large extent, on the intervention of the courts. The standing of the
courts and judges has improved over the years, especially with the creation of commercial
judges in Kuala Lumpur. As of a few years ago, there was a substantial backlog of
bankruptcy and winding-up cases throughout the Malaysian court system. However, a new
case management system has apparently significantly reduced the backlog of old cases as
well as made the handling of new cases more efficient. There is general satisfaction with the
quality of judges handling insolvency matters in Malaysia’s major commercial centers,
particularly in certain jurisdictions such as Kuala Lumpur where such matters are handled by
judges in a specially established Commercial Court.
96.
Laws are in place under which the banking system and the deposit insurer can
operate. The legal structure in Malaysia supports the banking system and the deposit insurer
although there is a need to develop a more modern insolvency regime for companies and
individuals. There are at present a number of credit information providers, with a supervisor
for the activities of all credit information systems, in line with best international practices.
97.
A legal framework exists for handling a bank failure that includes a method for
effective failure resolution in a timely manner. PIDM’s and BNM’s statutes provide for
various methods by which a financial institution can be effectively resolved. The factors that

58
govern decisions on early intervention and non-viability should be made part of PIDM’s
statute.
98.
Banking laws and regulations are updated as necessary to ensure that they
remain effective and relevant to a changing industry. Both PIDM and BNM have had
recent, extensive changes to their governing statutes. A significant effort is underway to
amend the Banking and Financial Institutions Act of 1989 with a very advanced draft
circulating for comment that BNM plans to table in the June Parliamentary session.
99.
Information exchange between the deposit insurance system participants and the
supervisor is legally protected for all measures necessary in order to protect the
deposits and to enable safety-net participants to intervene in case a bank is at risk. All
communications are subject to bank secrecy protections under Section 24 of the PIDM Act
and PIDM and BNM have ongoing access to information on MIs.
100. Appropriate participants in the financial safety net are entitled to protect
depositors through a number of options including transferring deposits from a troubled
bank to a healthy bank. PIDM has the power to transfer deposits from a troubled bank to a
Member Institution (MI) or other institution established for such purpose.
101. Relevant authorities can take legal action against the management of a failing
bank. There is authority to take action against those responsible for a failing or failed bank
both with PIDM (through a referral to the public prosecutor) and BNM. The public
prosecutor also has the authority to take action if appropriate under the Penal Code and a
liquidator may pursue a suit under the Companies Act if needed.
D. Sound Accounting and Disclosure Regime
102. Accounting and disclosure regimes support the ability of the supervisor and
deposit insurer to adequately evaluate the health of individual banks and the banking
system as a whole. Banking institutions in Malaysia are subject to Financial Reporting
Standards (FRS) established by the Malaysian Accounting Standards Board which are in full
compliance with the International Financial Reporting Standards (IFRS). Banking institutions
are also subject to additional disclosure requirements established by BNM, including the
Guidelines on Financial Reporting for Banking Institutions (requiring disclosures on
deposits, loans, impairment provisions and remuneration) and Pillar II disclosure
requirements under Basel II (risk management practices and the capital adequacy of banking
institutions). Banking institutions listed on the local stock exchange are subject to additional
disclosure requirements set forth by Bursa Malaysia Securities, the securities exchange. In
addition, the majority of locally owned banking institutions and several of the foreign owned
banking institutions with significant operations in Malaysia are rated by the domestic credit
rating agencies.

59
103. Accounting and disclosure regimes support the accurate and timely
identification of information on depositor accounts for the purposes of prompt
reimbursements. PIDM is able to collect information on depositors directly from its MIs.
PIDM also requires that MI’s external auditors validate filings made with PIDM for the
purposes of its Differential Premium System (DPS). There is also high level collaboration
and co-ordination between the accounting profession and the regulatory reporting agencies.
104. Accounting and disclosure regimes support the use of risk-adjusted differential
premium systems adopted by the deposit insurer. PIDM is able to validate its DPS both
directly with its MIs and through validation by MIs’ external auditors.
105. The deposit insurer has the right to carry out or provide for an audit or
inspection of a member bank in a timely manner if evidence shows that deposits may be
at risk. PIDM has special examination powers under Section 97 of its Act. Such an
examination may include the examination of records, books, accounts or other documents
and transactions of the MI.
E. Main Findings
106. The deposit insurance framework in Malaysia, managed by PIDM, broadly
conforms to best international practice. PIDM was established in 2005 under the Malaysia
Deposit Insurance Corporation Act (PIDM Act). PIDM administers a Deposit Insurance
System (DIS) which covers deposits in conventional and Islamic banks as well as a takaful
and insurance benefits protection system (TIPS) which insures policy owners and takaful
certificate holders against the loss of part or all of their benefits in the event of a member
institution failure. TIPS coverage was added to PIDM’s mandate on December 31, 2010.
Member institutions include all commercial banks, including locally incorporated foreign
subsidiaries, Islamic banks licensed under the Islamic Banking Act of 1983, all insurance
companies licensed under the 1996 Insurance Act except Danajamin Nasional Berhad and
takaful operators registered under the 1984 Takaful Act (except international takaful
operators). As of February 1, 2012, PIDM’s membership consisted of 41 banks
(25 commercial including 8 domestic and 16 Islamic banks) and 47 insurers (35 insurance
companies and 12 takaful operators). The top five commercial banks make up over
60 percent of total insured deposits.
107. PIDM is funded by annual premiums collected from member banks for both
conventional and Islamic deposits, with TIPS funded by annual levies for takaful and
insurance benefits. The funds for conventional and Islamic deposits are separately
administered with the Islamic deposit insurance fund administered in accordance with
Shariah principles. PIDM administers an additional four funds (Family Solidarity Takaful
Protection, Life Insurance Protection, General Takaful Protection and General Insurance
Funds) for a total of six separate and distinct Funds. PIDM reports to Parliament through the
Minister of Finance and is governed by a nine member Board of Directors, including two ex

60
officio members (the Governor of Bank Negara Malaysia and the Secretary General of
Treasury, Ministry of Finance).
108. Deposit insurance is compulsory for all deposit-taking conventional and Islamic
banks. PIDM protects all retail depositors, including corporate depositors, small businesses
and individuals, up to the maximum of RM 250,000 per depositor per member institution.
PIDM is legally mandated to reimburse depositors promptly, no later than 3 months after a
winding up order. The current reserve level for conventional deposits is 0.14 percent of total
insured deposits.
109. PIDM has a number of strengths, including a culture of cooperation with other
safety net players, strong performance in its exit from the Government Deposit
Guarantee (GDG), a robust public awareness program, ongoing efforts at readiness and
planning for potential financial institution resolutions and openness and transparency
in its operations and reporting. However, there are several areas for improvement, most
importantly the need for MoF to execute a back-up funding agreement with PIDM and to
limit MoF’s legislatively-mandated involvement in the day-to-day operations of PIDM. A
summary of the detailed assessment of compliance with the Core Principles is presented
below.
F. Malaysia’s Islamic Deposit Insurance System
110. PIDM was established in 2005 as a dual deposit insurance system. In addition to
covering deposits in conventional banks, PIDM also covers eligible Islamic deposits
(savings, current and investments accounts based on Shariah contracts including wadiah,
qard, mudharabah, murabahah and wakalah). The Shariah compliant design is based on an
arrangement of guarantee with fee or kafalah bil ujr. This system of insuring Islamic deposits
was endorsed by the Shariah Advisory Council of Bank Negara Malaysia.
111. The deposit insurance limit for Islamic deposits is at the same level as
conventional deposits—RM 250,000—and the limit is separate from the limit for
conventional deposits. There is also separate coverage for trust accounts, joint accounts,
professional practice, sole proprietorship and partnership accounts. Islamic and conventional
banking businesses pay separate premiums and PIDM manages an Islamic Deposit Insurance
Fund (IDIF) separately from its Fund for conventional deposits. Investments for the IDIF are
made in Shariah-compliant instruments. Expenditures are charged to IDIF directly if
attributable to Islamic member institutions and charged proportionately between Funds if the
expenditures are not directly attributable.
112. In 2010 PIDM’s mandate was enlarged to protect takaful and insurance
certificate owners in the event of an insurer member failure. The takaful benefits
protection system was also endorsed by the Shariah Advisory Council.

61
G. Summary of Compliance and Recommended Actions
Table 7. Summary of Compliance with the Deposit Insurance Core Principles

Principle
1. Public Policy
Objectives (PPOs)
2. Mitigating Moral
Hazard

3. Mandate

4. Powers

5. Governance

6. Relationship with
Other Safety Net
Participants

Comments
PPOs are explicitly stated in the PIDM Act and are also regularly discussed in
PIDM’s Annual Reports and made part of its Corporate Plans, including the
current Plan for 2012-2014.
All appropriate design features are present in the PIDM framework. The
PIDM has limited coverage in the amount of RM 250,000, an amount that
covers 99% of depositors in the system but only 36.9% of total conventional
and Islamic bank deposits held by member institutions. PIDM also has in
place a Differential Premium System as authorized by Article 53 of its Act so
that higher deposit insurance premiums are charged for banks that fall into
higher risk categories.
PIDM’s mandate includes sound risk management as well as a role in the
resolution process for non-viable banks. The preamble to its governing Act
states that PIDM is empowered to implement promptly authorized resolution
actions at minimum cost to the financial system. Article 4 of its Act also states
that PIDM should, in achieving its PPOs, act in such manner as to minimize
costs to the financial system. PIDM’s powers are described in Sections 25
and 99 of its Act as including all powers as may be necessary for the
furtherance of its objectives or the performance of its functions and duties.
PIDM has been given significant powers to operate in accordance with its
mandate, including the powers needed to perform its resolution functions.
PIDM also has early intervention powers under Section 25 of its Act.
Although there are no examples of any interference with PIDM’s operational
independence, there are a large number of approvals it must seek from MoF
in performing its functions. These approvals present the possibility that
PIDM’s independence or effectiveness in meeting its mandate could be
compromised or necessary actions could be delayed by the need to seek
approval from MoF. These approvals are especially unnecessary given that
the Secretary General of the Treasury is an ex-officio member of PIDM’s
Board. PIDM can only take the following actions with Minister of Finance
approval: termination of membership (Section 39), setting annual premium
rates (Section 48), assessing a premium surcharge against a member
institution as a penalty for failing to comply with rules, regulations, its terms
and conditions of membership or other requirements of PIDM or BNM
(Sections 51, 153), making discretionary payments of insured deposits where
a member institution is unable to make such payment for specified reasons
(Section 57) and issuing rules, regulations or orders (Section 209).
There is a strong culture of cooperation between PIDM and other safety net
players. PIDM and BNM work closely on major initiatives and share all
relevant information on a regular basis, with PIDM having ongoing access to
BNM’s supervisory files. PIDM is a risk manager for its MIs and shares all its
information with BNM. An appropriate national crisis management framework
for managing a financial crisis should be established to include all safety net
players.

62
Principle

Comments

7. Cross-border Issues

All foreign banks in Malaysia are licensed as subsidiaries and their deposits
are covered by PIDM. BNM shares information with PIDM about cross-border
banks that it obtains as a result of its formal and informal agreements and
ongoing cooperation with relevant foreign home and host authorities.
However PIDM should consider entering into agreements with deposit
insurers in relevant jurisdictions for the purpose of resolution planning and
exchange of deposit data and other information to facilitate resolution of a
bank with cross-border operations.
All commercial banks regulated by BNM are required to be members of
PIDM. However, there are a number of financial institutions that take deposits
from the public that are not part of the PIDM deposit insurance system.
Several of these institutions are covered either by explicit or implicit
Government guarantees but others (the credit cooperatives) are not covered
by any insurance scheme. These cooperatives (with one exception) are not
supervised by BNM but rather by the Malaysia Co-operative Societies
Commission.
The level of coverage is limited to RM 250,000 per insured account, an
amount which covers almost 99% of depositors but only 36.9% of deposits
held by MIs.
Malaysia successfully exited from a Government Deposit Guarantee (GDG)
at the end of 2010 with careful planning and an effective communications
strategy. At the same time as it exited from the GDG the law was amended
with a substantial increase in deposit insurance coverage, from RM 60,000 to
RM 250,000.
PIDM has established a Target Fund and has determined that it will reach
that funding level in ten to twelve years. As a relatively new deposit insurer
the current level of PIDM’s reserves is small and may not be sufficient to
handle the resolution costs of a medium-sized bank. For that reason it is even
more critical that adequate liquidity funding be available. However, PIDM’s
statute provides only that MoF “may” lend money or provide funds to PIDM
(Article 29 of the PIDM Act) and no funding agreement is in place that would
make clear that such funding would be available when needed and under
what conditions.
PIDM has a comprehensive public awareness program and works closely
with member institutions to make sure the public is aware of the existence
and limits of coverage on their accounts. New deposit products must be
submitted to PIDM for a determination of insurability.
Under section 207 of the PIDM Act directors, officers and employees of PIDM
as well as its subsidiaries and a bridge institution are granted immunity from
suit for actions taken in good faith while discharging PIDM’s mandate. Costs
associated with any suit for current and former directors and employees
would be covered by PIDM pursuant to a written policy.
Relevant authorities have the power to seek legal redress against parties at
fault in a bank failure.
PIDM undertakes insurance and risk assessment to assess and monitor the
risk inherent in providing deposit insurance. PIDM and BNM have developed
early intervention and non-viability criteria as part of the Strategic Alliance
Agreement (SAA). PIDM has developed an Intervention and Failure
Resolution Framework (IFR) which sets forth its powers in responding to a
failing MI. The SAA outlines the working arrangements between BNM and

8. Compulsory
Membership

9. Coverage

10. Transitioning from
Blanket Guarantee

11. Funding

12. Public Awareness

13. Legal Protection

14. Dealing with Parties
at Fault
15. Early Detection and
Timely Intervention and
Resolution

63
Principle

16. Effective Resolution
Processes

17. Reimbursing
Depositors

18. Recoveries

Comments
PIDM during the stages of planning for and undertaking an intervention and
sets forth a PIDM Board approved Authority Matrix t o define the roles of the
two agencies (the Governor of BNM is an ex officio member of PIDM’s
Board).
Once BNM issues a non-viability determination for a MI, PIDM has the power
to resolve the institution using a variety of resolution tools, including the
assumption of control of a MI, purchase and assumptions and bridge banks.
PIDM must seek High Court approval for the appointment of a Receiver or a
winding up order which may make these tools less effective in terms of
providing certainty as to the timing of such actions by PIDM, although by
assuming control under Section 99 of its Act the appointment of a receiver
may not be critically time sensitive. The requirement that BNM declare an
institution non-viable before PIDM can undertake resolution actions also
presents the possibility that action will not be taken early enough to allow for
effective use of all of PIDM’s resolution tools especially given the absence of
any definition of the term “non-viable” in the relevant legislation.
Under Section 56 of its Act PIDM is obliged to make payments to depositors
as soon as possible and not later than three months after a winding up order.
Payments are computed as of the date of the filing of the petition for winding
up (Section 59). PIDM has continuous access to information on its MIs and
can require such institutions to provide it with depositor data on a priority
basis if necessary. PIDM has the authority under Section 58 of its Act to
make advance payments if necessary.
PIDM has control over the liquidation process under Sections 131 and 133 of
its Act through its powers to direct the liquidator’s actions. PIDM is a creditor
of the failed bank’s estate and is subrogated to the depositor’s rights and
interests on the deposit for any payments made to depositors. PIDM has
developed an Asset Management and Disposition Policy which governs its
actions when handling asset recovery.

64
Table 8. Recommended Action Plan—Deposit Insurance Core Principles
Principle
5.Governance

8. Compulsory
Membership

11. Funding

13. Legal Protection
16. Effective Resolution
Processes

Recommended Action
The MoF should request that PIDM bring forward amendments to its enabling
statute to remove those areas of approval that may interfere with its
operational independence and effectiveness, such as approvals to set annual
premium rates (Article 48), assess a premium surcharge (Article 51), issue
rules and regulations (Article 209) and make discretionary payments of an
insured deposit (Article 57) as well as the ability to disagree with PIDM on the
termination of membership of a member institution (Article 39).
A study should be undertaken to understand whether deposits at the DFIs
and credit cooperatives qualify as deposits within the meaning of the terms
“conventional deposit” or “Islamic deposit” under PIDM’s Act. To the extent
that such institutions are deemed to be deposit taking, consideration should
be given to the supervisory and regulatory framework under which those
institutions operate that are not members of PIDM. Only those institutions that
are subject to strong prudential regulation and supervision and are financially
viable should be considered for membership in a deposit insurance system.
The extent of coverage if any for depositors at any institution that is not part
of the deposit insurance system should be made clear in communications to
depositors at those institutions.
MoF should execute an agreement for back-up funding to make clear the
obligation by the government to provide such funding if needed by PIDM to
meet its mandate and to set out the process by which such funding should be
requested and how it would be made available.
PIDM should make coverage of former employees explicit in providing legal
protection for protected acts done in the course of their employment.
There is no statutory definition of non-viability. The criteria governing early
intervention in a MI and for a determination of non-viability should be
transparent and disclosed by amending PIDM’s statute.

65
V. SUMMARY ASSESSMENT OF OBSERVANCE OF THE CPSS-IOSCO PRINCIPLES FOR
FINANCIAL MARKET INFRASTRUCTURES
A. Introduction
113. The assessment of observance of the CPSS-IOSCO Principles for Financial
Market Infrastructures (PFMI) for Malaysia was conducted in mid-2012. The revised
PFMIs were only adopted as an updated international standard in early 2012, and Malaysia is
among the first jurisdictions to be assessed under the newly revised standard.12
B. Institutional and Market Structure
114. There is a clear demarcation of oversight, regulatory and supervision
jurisdiction between the Securities Commission and the central bank. The Bank Negara
Malaysia (BNM), the central bank, is responsible for the oversight of the payment systems
and settlement systems for unlisted government, BNM and private debt securities. The
Securities Commission (SC) is responsible for the regulation, supervision and oversight of
the FMIs for the corporate securities and derivatives markets.
115. MyClear, a 100 percent owned subsidiary of the BNM, operates an integrated
large value payment and securities settlement system—RENTAS. RENTAS functions as
a Real-Time Gross Settlement System (RTGS) which is integrated with a centralized
securities depository (CSD) and also handles securities settlement of unlisted Government,
BNM and private debt securities.
116. The securities and derivatives clearing and settlement infrastructure is managed
by the integrated exchange holding company Bursa Malaysia (BM). BM is licensed as an
exchange holding company and has a 100 percent owned subsidiary Bursa Malaysia
Securities (BMS), a securities exchange, and a joint venture with the Chicago Mercantile
Exchange (CME), Bursa Malaysia Derivatives (BMD), that is licensed as a derivatives
exchange. Each of the exchanges has a central counterparty (CCP) for the respective market:
Bursa Malaysia Securities Clearing (BMSC; wholly-owned by BM) for the securities market
and Bursa Malaysia Derivative Clearing (BMDC; wholly-owned by BMD) for the
derivatives market. The BM also has a 100 percent owned subsidiary BMDepo that functions
as the lone CSD for the securities traded on the BMS.
117. The BM had planned a default drill for its FMIs well before the FSAP
assessment and this has been taken into account in the assessment however the actions
taken by the FMIs and authorities subsequent to the FSAP while being acknowledged
are not being taken into account in the assessment. The default drill was proposed in
12

The assessor was Harish Natarajan of the World Bank and was supported by Isaku Endo (also World Bank).

66
January 2012 and was planned to be executed in December 2012. The assessors were notified
of the successful conduct of this and also the plans to conduct this on a periodic basis. The
principle 13 (default procedures) and principle 14 (segregation and portability) for the BMSC
and the BMDC have been assessed taking this into account. A number of other initiatives
have been taken post the FSAP assessment that could address specific gaps identified in the
FSAP. These are acknowledged, but the assessment does not take these into account as part
of the rating for the impacted principles and responsibilities. These initiatives include
enhancement of stress testing scenarios and overall credit risk framework by the BMSC and
BMDC; institution of liquidity risk management stress tests by the BMSC and the BMDC;
and, the enhanced MOU entered into between the SC and the BNM and the establishment of
a focus group to discuss co-operative oversight arrangements.
C. Payments System and Bond Clearing and CSD
118. The RENTAS system was assessed with the CPSS-IOSCO Principles for
Financial Market Infrastructures (PFMI) as a unified system although, from a technical
standpoint, it involves the operation of three FMIs. The rationale of this choice was that
the system is highly integrated. A few areas of further improvement are noted.


Legal Basis: The legal framework explicitly provides for finality. However the
certainty of protection of collateral placed for liquidity support and protection of
repo arrangements is not explicit. This is not an immediate concern as all the
participants that use these facilities are supervised by the BNM and the BNM is
responsible for initiating insolvency/bankruptcy proceedings for these entities,
however when other classes of entities are allowed this could be an area of
concern.



Collateral: The valuation of collateral placed for intra-day credit facility which
could be converted to overnight credit is based on quotes from principal dealers.
This could be enhanced by seeking quotes from the Bond Pricing Agency.



CSD: The segregation arrangements for the customers that have been provided
for in the legal framework should be tested and procedures for implementing
portability should be tested.



Disclosure Framework: The RENTAS is required to comply with the relevant
CPSS-IOSCO standards with the introduction of the PFMIs the RENTAS should
comply with the disclosure requirements as well.

67
D. Securities Clearing and CCP
119.

The main findings for BMSC are:



Legal Basis: The legal framework for the securities market explicitly provides for
finality and protection for collateral but explicitly recognizes netting and novation
only at the level of rules. An independent legal opinion has confirmed the
enforceability of the rules; however as part of the proposed Financial Services Act
these can be addressed at the level of law as well.



Credit Risk: The stress testing models need to be enhanced and reviewed
monthly against the current quarterly review schedule. The BMSC does not
collect margins and the resources used for handling credit risk is the clearing
guarantee fund, the SBL-CLA collateral for SBL-CLA related exposures and in
addition the liquid assets of the BMSC. The size of the clearing guarantee fund
should be enhanced to ensure that committed funds are adequate to handle the
default of the participant with the largest exposure. Stress tests in 2011 indicated
the committed funds would be just about sufficient, however after inclusion of the
stand-by credit facility from the BM defaults of the three participants with the
largest exposures could be handled.



Margin: The BMSC has established a clearing guarantee fund that is pre-funded
by the participants, the BMSC and the stand-by credit arrangement from the BM.
This fund is structured to cover the potential exposure of the BMSC from the
settlement default of the novated trades of a participant with the largest settlement
position. The structure and the objective of the clearing fund do not fully conform
to the margin methodology envisaged for the PFMIs. The BMSC should consider
instituting a margin mechanism, this can be done by recasting a part of the CGF
as a margin which is collected based on the positions of the participants and also
have the ability to collect variation margin on an intra-day basis.



Liquidity Risk: The BMSC does not have an explicit stress testing model for
assessing its liquidity risk. The BMSC should institute this and also subject it to
periodic review.



Exchange of value: The DVP mechanism is achieved by placing a system-wide
freeze on the CSD until the funds leg is completed. However buy-ins initiated to
address delivery failures can over-ride the freeze and there could be a scenario
where a participant receiving securities as part of the days’ settlement and
participate in the buy-in using those securities even before his fund pay-in and
potentially default on his funds obligation. This risk is however mitigated by the
operational controls required to be instituted by the participants, which ensure that
the participant’s clients cannot participate in the buy-in process without them first

68
having met their settlement obligations for the day. The BMSC should ensure that
the CSD systems prevent the above scenario from happening or alternatively
ensure that the market participants exercise specific operational controls in their
processes to prevent this from happening.


Default procedures: At the time of the FSAP assessment the BMSC had
proposed to carry out a default drill in December 2012 and on a periodic basis
thereafter. The assessor was notified about the successful completion of the
default drill as planned. The BMSC should ensure that the drill is carried out on
an ongoing basis and also any gaps or issues identified are addressed in a timebound manner.



Operational Reliability: The BM manages the BCP at a group level and has a
stated Recovery Time Objective (RTO) of 5.5 hours for critical function which
includes depository, clearing and settlement arrangements. The BMSC does not
fully test the reliability of the participants BCP procedures.
E. Central Securities Depository

120. The operational reliability issue mentioned for the BMSC applies for the
BMDepo as well.
Derivatives Clearing and CCP
121.

The main findings for BMDC are:



Legal Basis, default procedures and operational reliability: The observations
related to these principles summarized above for the BMSC are applicable to the
BMDC as well.



Credit Risk: The stress testing models need to be enhanced and reviewed
monthly against the current quarterly review schedule.



Margin: The Margin model is currently only reviewed twice a year it should be
reviewed every month with a full-fledged review once a year.



Liquidity Risk: The BMDC does not have an explicit stress testing model for
assessing its liquidity risk. The BMDC should institute this and also subject it to
periodic review.

Supervisory Oversight


Responsibility C: The authorities currently do not have a formal mechanism for
disclosing their oversight policies with respect to the FMI’S for the securities and
derivatives market. The oversight policies for the payment systems are shared in

69
the annual financial stability report, however the extent of coverage could be
enhanced and other delivery mechanisms could be considered.


Responsibility E: The co-operative arrangements in place should be fully
leveraged and the extent of information and scope of collaboration could be
enhanced. Information sharing related to concentration limits in settlement banks
and letter of credits could be enhanced. The scope of collaboration could be
enhanced to jointly explore aspects related to FMIs on an ongoing basis.
F. Key Recommendations for FMIs
Table 9. FMI Recommendations—RENTAS (RTGS, CSD and SSS)

Principle

Issue of concern
and other gap or
shortcoming

Recommended action and comments

Testing of default
management procedures

MyClear should introduce periodic testing of the
default management procedures and involve the
participants also.

Articulate how the CSD
would support the portability
of client holdings.

MyClear could enhance their disclosures related to
RENTAS and test their ability to support portability of
client holdings.

Comply with the disclosure
framework requirements.

All the FMIs should comply with the disclosure
framework requirements as part of their ongoing
compliance to the regulatory and oversight
requirements.

The legal framework could
be strengthened to provide
explicit protection for the
collateral placed for intraday credit in the RENTAS
and also for repo
arrangements.

The provisions in the CMSA that provides for primacy
of the default procedures of the BMSC and BMDC
over any insolvency related proceedings could be
replicated for the RENTAS as well perhaps in the
PSA or in the upcoming Financial Services Act.

The valuation for the PDS
accepted as collateral for
the ICF should also include
price information from the
Bond Pricing Agency.

Currently the price quotes are collected from the
principal dealers only. The reliability of the price
estimates could be enhanced by taking quotes from
the Bond Pricing Agency.

Enhancing the operational
reliability through more
robust verification of
participants BCP.

RENTAS has a robust BCP; the operational reliability
of the whole system can be enhanced by robust
verification of the participants BCP arrangements for
(e.g.) by requiring external certification of participants
BCP. In addition exceptional scenarios like RENTAS
experiencing operational issues close to end-ofbusiness day, unusual queue sizes, and high number
of requests for ICF etc. could be included in the BCP
testing.

70
Table 10. FMI Recommendations—BMDC

Principle

Issue of concern
and other gap or
shortcoming

Recommended action and comments

There is no stress testing
model used for monitoring
liquidity risk.

The BMDC currently use the results of the credit risk
stress to monitor liquidity risk. In addition to this they
should create specific models for assessing liquidity
risk, this could include for (e.g.) simulating
unavailability of one or more banks with which they
maintain their liquid assets.

Testing of default
management procedures

Testing and validation of
segregation and portability
arrangements

The assessor was notified that the BMDC has
conducted the planned default drill and also that this
drill is planned to be conducted on a periodic basis.
The BMDC should ensure this is incorporated as an
ongoing activity and any gaps or issues identified are
addressed in a time-bound manner.
The BMDC should verify and test its ability to assist
movement of customers’ positions from a defaulting
participant to another. The assessor was notified that
this was included in the default drill conducted in
December 2012. The BMDC should ensure that this
is included in future default drills as well and any
gaps or issues identified are addressed in a timebound manner.

Comply with the disclosure
framework requirements.

The CMSA and the SCA do
not explicitly recognize
netting and novation. These
are however addressed in
the default procedures of the
BMDC which have primacy
in the event of insolvency of
a participant.
Achieve RTO of less than
two hours and be able to
continue performing from
DR site for prolonged period
of time

The settlement is currently
in commercial bank money.

All the FMIs should comply with the disclosure
framework requirements as part of their ongoing
compliance to the regulatory and oversight
requirements.
The provisions in the PSA related to finality, netting
and novation can be replicated for the BMSC and
BMDC. This could be addressed as part of the
upcoming Financial Services Act which envisages
empowering the BNM to declare the BMSC and
BMDC as designated payment systems.
The RTO of the BMDC is currently more than 2
hours. The BCP and all associated processes,
systems and procedures should be structured to
achieve this objective. In addition this should be
periodically tested. The BMDC should also institute a
robust process for ascertaining the effectiveness of
the BCP of the liquidity providers, settlement banks
and banks where it holds its and participants funds.
It is recommended that the BMSC and BMDC in a
time-bound manner migrate settlement from
commercial bank money to central money in the
RENTAS. This would need the active involvement of
the SC and the BNM.

71
Table 11. FMI Recommendations—BMSC
Principles
4

Issue of concern
and other gap or
shortcoming
The stress testing
methodology is inadequate
and the size of the clearing
guarantee fund is likely
inadequate as well.

The BMSC CGF
mechanism does not fully
conform to the margin
requirement of the PFMI.

There is no stress testing
model used for monitoring
liquidity risk.

Testing of default
management procedures

Testing and validation of
segregation and portability
arrangements

Comply with the disclosure
framework requirements.

The CMSA and the SCA do
not explicitly recognize
netting and novation. These
are however addressed in

Recommended action and comments
The stress testing of the BMSC should incorporate
the SBL and BFF related credit risks as well and
include more robust scenarios for (e.g.) stock specific
movements. In addition the BMSC could consider the
following to further strengthen the credit risk
management framework: (i) stand-by credit of the
BM should be converted into an explicit BM
contribution to the CGF; (ii) evaluate the relevance of
the BFF given its limited usage and encourage the
participants to use credit facilities from the banks;
and, (iii) on an ongoing basis enhance the stress
testing process by including scenarios that cover
other market factors, stock specific movements and
forward looking scenarios and review them on a
more frequent basis.
An initial and variation margin mechanism should be
instituted at the earliest. A portion of the participant’s
contribution to the CGF can be collected as margin.
This component should be collected based on the
participant specific risks and computed on a daily
basis and also have the ability to collect on an intraday basis.
The BMSC currently use the results of the credit risk
stress to monitor liquidity risk. In addition to this they
should create specific models for assessing liquidity
risk, this could include for (e.g.) simulating
unavailability of one or more banks with which they
maintain their liquid assets in particular in periods of
heightened liquidity stress and over multi-day periods
The assessor was notified that the BMSC has
conducted the planned default drill and also that this
drill is planned to be conducted on a periodic basis.
The BMSC should ensure this is incorporated as an
ongoing activity and any gaps or issues identified are
addressed in a time-bound manner.
The BMSC should verify and test its ability to assist
movement of customer’s positions from a defaulting
participant to another. The assessor was notified that
this was included in the default drill conducted in
December 2012. The BMSC should ensure that this
is included in future default drills as well and any
gaps or issues identified are addressed in a timebound manner.
All the FMIs should comply with the disclosure
framework requirements as part of their ongoing
compliance to the regulatory and oversight
requirements.
The provisions in the PSA related to finality, netting
and novation can be replicated for the BMSC and
BMDC. This could be addressed as part of the
upcoming Financial Services Act which envisages

Principles

Issue of concern
and other gap or
shortcoming
the default procedures
which have primacy in the
event of insolvency of a
participant.
The DVP arrangements
need to be tightened.

Achieve RTO of less than
two hours and be able to
continue performing from
DR site for prolonged
period of time

The settlement is currently
in commercial bank money.

Recommended action and comments
empowering the BNM to declare the BMSC and
BMDC as designated payment systems.
DVP is currently achieved by placing a system-wide
freeze on the BMDepo which is released only when
the funds leg is completed. There is however an
exception allowed for participating in a buy-in. A
system check should be instituted to ensure that a
participant receiving securities as part of the days’
delivery cannot participate in the buy-in with those
securities. Alternatively the BMSC could ensure that
the operational controls that the market participants
are required to enforce as per the BMS rules to
prevent this from happening is indeed enforced on an
ongoing basis.
The RTO of the BMSC is currently more than 2
hours. The BCP and all associated processes,
systems and procedures should be structured to
achieve this objective. In addition this should be
periodically tested. The BMSC should also institute a
robust process for ascertaining the effectiveness of
the BCP of the liquidity providers, settlement banks
and banks where it holds its and participants funds.
It is recommended that the BMSC and BMDC in a
time-bound manner migrate settlement from
commercial bank money to central money in the
RENTAS. This would need the active involvement of
the SC and the BNM.

Table 12. FMI Recommendations—BMDepo
Principle

Issue of concern
and other gap or
shortcoming

Recommended action and comments

Articulate how the CSD would
support the portability of client
holdings.

The BMDepo could enhance their disclosures and test
their ability to support portability of client holdings.

Achieve RTO of less than two
hours and be able to continue
performing from DR site for
prolonged period of time

The RTO of the BMDepo is currently more than 2
hours. The BCP and all associated processes,
systems and procedures should be structured to
achieve this objective. In addition this should be
periodically tested.

Comply with the disclosure
framework requirements.

All the FMIs should comply with the disclosure
framework requirements as part of their ongoing
compliance to the regulatory and oversight
requirements.

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Table 13. FMI Recommendations—Authorities
Responsibility

Issue of
concern
and other gap or
shortcoming

Recommended action and comments

Responsibility C

Disclosure of
Oversight policies

The SC and the BNM could enhance
their disclosure of oversight policies to
the public. The disclosure to the FMIs is
adequate.

Responsibility E

Co-operation
arrangements

The co-operation framework is in place;
however, the SC and the BNM should
operationalize the co-operation in the
area of oversight of the FMIs by
expanding the scope of information
exchange on an ongoing basis and
initiating joint efforts to enhance safety,
efficiency and reliability for the payment
and settlement systems. The BNM and
the SC can consider leveraging the new
MOU framework to enhance the
operational co-ordination. These could
include areas like sharing information
relating to the ongoing oversight
assessments of the FMIs in their
respective jurisdictions and measures to
enhance the risk management
framework in the FMIs in their
respective jurisdiction by sharing
information that could be pertinent to
the overseer of a particular FMI.

G. Authorities’ Response to the Assessment
122. BNM and SC would like to thank the FSAP mission team for the substantive
discussions, comprehensive assessment and recommendations in relation to the recently
issued Principles for Financial Market Infrastructures (FMI) assessment. The high level
of observance accorded to RENTAS, BMSC, BMDC and BMDepo in this assessment under
the more stringent FMI principles demonstrates that the strategic “roadmap” and the
oversight approach adopted by the both BNM and SC in regulating these infrastructures have
been effective. Given the robust payment and settlement framework already in place, BNM
and SC have been able to fully implement many of the recommendations made by assessors,
while others are in the midst of being implemented.
123. Malaysia has been committed to continuously benchmarking itself against
international standards and best practices. In the case of the capital market, in 2008, we
voluntarily underwent an independent assessment to benchmark our compliance with the

74
IOSCO Objectives and Principles of Securities Regulation (IOSCO Principles), and this
included our assessment on compliance with CPSS-IOSCO Recommendations for Securities
Settlement Systems (SSS).
124. The FMI assessment was a particularly challenging one to undertake. In relation
to the capital market, we had initially used the CPSS-IOSCO Recommendations for SSS and
Central Counterparties (CCP), and its related methodology, to conduct the self-assessment of
payment, clearing and settlement assessments; the FMI principles had not been officially
released at the time of the self-assessment, and the FMI methodology was not finalized and
still in the process of international consultation. Nevertheless, we were subsequently
persuaded by the FSAP team to use the new standards and methodology. The FSAP mission
provided a “patch” with which we conducted a further round of self-assessment to bridge any
gaps between the CPSS-IOSCO recommendations and the FMI principles. During the
assessment discussions, however, the guiding documents were the new FMI principles and
the accompanying methodology, resulting in ratings being based entirely on strict application
of the new methodology. Given the absence of a “track record” of assessments under the new
FMI principles, we were disadvantaged by the inability to exercise flexibility and apply the
principles to circumstances peculiar to Malaysia.
125. An important issue for the capital market is that while we have been assessed by
global standards, application of the methodology must be done within the context of the
structure and characteristics of the domestic financial sector. In the case of the FMI, the
evaluation of systems, processes etc in place must take cognisance of the structure of the
Malaysian financial sector. This also requires that the assessment must give sufficient weight
to the outcome achieved, even if the implementation of a particular principle does not match
exactly the approach described by the methodology, especially when such an outcome
sufficiently contributes to the effectiveness and soundness of the payments and settlement
systems.
126. For example, stress testing should be commensurate with the risks in the
Malaysian capital markets. While we do not disagree with the view that there is a need to
build scenarios for stress-testing that incorporates extreme possibilities, the assessment
should give due recognition to regulatory equivalence, namely the features of the country
financial sector and existing frameworks which act to build regulatory strength and reinforce
each other in a manner expected of that particular principle. Risks scenarios must be
appropriate, and avoid detrimentally-high costs of capital and operations. Good regulatory
practice requires that measures are proportionate to the specific needs of financial system
being assessed, and should minimise the risk of inefficiencies and loss of competitive
position due to a high burden of regulation.
127. Therefore, an important lesson from the capital market’s experience of the FMI
assessment is that assessors should consider giving due recognition to the outcomes of
measures and not just the measures in place. The methodology does give options to

75
regulators on the means to achieve the results intended to be measured by the FMI standard.
Given that there are likely to be many ways of achieving the expected outcome, the
assessment would provide even more value, and lead to recommendations that are more
meaningful to regulators and policy makers, if greater attention is given to actual results of
measures.
128. The SC and BNM work closely together to ensure financial stability and this has
significantly helped to build market confidence and manage systemic risks issues. In the
case of FMI, the SC and BNM continuously engage, share information and co-operate very
closely and undertake pre-emptive interventions where necessary. The regulatory framework
in Malaysia is underpinned by a structure and practice of coordination between SC and BNM
at various levels on operations and policy. The effectiveness of such close collaboration has
been tested and demonstrated in avoidance of defaults and early management of problem
issues.
129. There are several principles assessed that we view as not taking into account the
contextual considerations. These include:


The issue of Bridging Finance Facility (BFF) not included by BMSC in its stress
testing -- taking the contextual argument, assessors need to give weight to outcomes,
that the utilisation rate of the facility is very insignificant and that the PO’s financial
standing is relatively strong. Moreover, Bursa Malaysia has intention to remove the
BFF.



Scenarios for assessing robustness stress testing in relation to the capital markets –
the scenarios for stress testing should take into account other market factors, adverse
movement in more than one product and other forward looking stress scenarios. The
stress testing scenarios should be proportionate to risks in the Malaysian capital
markets. The 5 additional scenarios for stress test undertaken soon after being
informed by assessors showed results that such additional factors did not post a
significant loss to the Clearing Fund and the financial resources remain adequate.
This again begets the point that outcomes should matter. The fact that we can quickly
implement a shortcoming almost immediately after it being pointed out by assessors,
indicate the robustness of the risk framework. Due weight should be given to the
underlying framework and the results of the test, not just when the additional
scenarios were tested.



Requirement for margins in the securities trading. The principle on margin
requirements for securities markets was first assessed as “not applicable” for the
clearing of securities at the first round of assessment in July 2012. However, post peer
review, the pendulum was swung to the other extreme, whereby this principle was not
only reclassified as applicable to the securities clearing but rated as “not observed”.
Such a rating implies that the BMSC allows its Trading Clearing Participants (TCPs)

76
to trade and clear their trades without any form of collateral or protection against
potential TCP default, that trades on the Malaysian securities market are cleared by
BMSC without any safety net. On the contrary, Malaysia has put in place a collateral
system proven to be as effective as the margin requirements. While there is an
alternative system in place that may not meet all the requirements of a margin system,
credit must be given to the existence of such a system of pooled collateral that
broadly achieves the intended results and objectives of a margin system. Further this
alternative system of clearing and settlement is recognised in the FMI principle.
Going Forward
130. The SC’s efforts to enhance the efficiency of the trading, clearing and settlement
infrastructure have been articulated in both CMP1 (2001-2010) and CMP2 (2011-2020).
In CMP1, we recognised that an efficient trading, clearing and settlement infrastructure helps
make more instruments accessible to larger pools of liquidity at minimal cost. Therefore ongoing benchmarking of the trading, clearing and settlement standards and processes against
international best practices remain a key priority, particularly where there is a need to further
enhance the market infrastructure and regulatory framework.
131. In CMP2, we recognised that, although the trading infrastructure for equities,
derivatives and bonds has already been enhanced to improve market access and
connectivity, given the changing intermediation landscape, market participants require
a further reduction in friction costs and a seamless post-trade infrastructure for
clearing and settlement. Areas identified under CMP2 include enhancing post-trade
settlement efficiencies through the implementation of straight through processing
capabilities. This will involve identifying required improvements in clearing and settlement,
depository, custody and collateral management practices, and the requirements to facilitate
integration of clearing and settlement with the payments system. Integration of the money
market and exchange-traded settlement systems will offer major benefits and help reduce
settlement risk by introducing finality and certainty to payments. Other areas to be addressed
include reducing the gap on the delivery-versus-payment arrangements and strengthening the
process for failed trades.
132. We will take on board recommendations to improve efficiency for a seamless
post trade infrastructure for clearing and settlement. We are revamping our Guidance on
the Regulatory Role of Bursa Malaysia this year, and in line with FMI standards will
introduce specific requirements and obligations on the clearing, settlement and depository
services provided by Bursa Malaysia, such as enhancements to credit and liquidity risk
management, strengthening collateral management practices and improving information
sharing, supervision and surveillance of the clearing and settlement activities with a view to
better monitor, mitigate and manage systemic risk to the financial sector.

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Malaysia CR1353

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