Malaysia CR1353

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IMF Country Report No. 13/53

January 28, 2013 January 29, 2001 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

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

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

GLOSSARY

AML/CFT Anti-Money Laundering/Counter Financing of Terrorism

BAFIA Banking and Financial Institutions Act 1989

BCBS Basel Committee on Banking Supervision

BCPs Basel Core Principles

BFF Bridge Financing Facility

BM Bursa Malaysia

BMD Bursa Malaysia Derivative Berhad (the derivatives exchange)

BMDC Bursa Malaysia Derivative Clearing

BMDepo Bursa Malaysia Depository Sdn Bhd (the central depository)

BMS Bursa Malaysia Securities Berhad (the stock exchange)

BNM Bank Negara Malaysia

CAR Capital Adequacy Ratio

CBA Central Bank of Malaysia Act 2009

CCP Central Counterparty

GDG Government Deposit Guarantee

CGF Clearing Guarantee Fund

CME Chicago Mercantile Exchange

CMSA Capital Markets and Services Act 2007

CPs Core Principles

CPSS Committee on Payment and Settlement Systems

CSD Central Securities Depository

DIS Deposit Insurance Scheme

DFI Development Finance Institution

DPS Differential Premium System

DVP Delivery versus Payment

FHC Financial Holding Company

FMI Financial Markets Infrastructure

FRS Financial Reporting Standards

FSA Financial Services Act

FSAP Financial Sector Assessment Program

FSEC Financial Stability Executive Committee

FSPSR Financial Systems and Payment Systems Report

IBA Islamic Banking Act 1983

ICAAP Internal Capital Adequacy Assessment Program

IDIF Islamic Deposit Insurance Fund

IFRS International Financial Reporting Standards

IOSCO International Organization of Securities Commissions

IRB Internal Rating Based

LFSA Labuan Financial Services Authority

MASB Malaysian Accounting Standards Board

MI Member Institution

MoF Ministry of Finance

SC Securities Commission Malaysia

NPL Non-Performing Loan

PDS Private Debt Securities

PIDM Malaysia Deposit Insurance Corporation

PFMI CPSS-IOSCO Principles for Financial Markets Infrastructure

RM Malaysian Ringgit

RENTAS Real Time Electronic Transfer of Funds and Securities

ROSC Report on Observance of Standards and Codes

RTGS Real Time Gross Settlement System

RTO Recovery Time Objective

SAA Strategic Alliance Agreement

SBL Securities Borrowing and Lending

SC Securities Commission Malaysia

SCA Securities Commission Act 1993

SKM Cooperatives Commission

SME Small and Medium Enterprises

SRU Specialist Risk Unit

SSS Securities Settlement System

SuRF Supervisory Risk Based Framework

TIPS Takaful and Insurance Benefits Protection System

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 end-

March 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.

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

staff).

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

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

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;

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.

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 co-

regulate.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.

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

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 off-

site 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.

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.

Table 1. Summary Compliance with the Basel Core Principles—Detailed Assessments

Core Principle Comments

1. Objectives,

independence,

powers, transparency,

and cooperation

1.1 Responsibilities

and objectives

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.

1.2 Independence,

accountability and

transparency

 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.

1.3 Legal framework  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.

1.4 Legal powers BNM has the authority to address compliance with laws and safety and

soundness concerns through a broad grant of legislative authority.

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.

1.6 Cooperation 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.

2. Permissible

activities

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.

3. Licensing criteria 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;

4. Transfer of

significant ownership

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

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.

5. Major acquisitions 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.

6. Capital adequacy 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.

7. Risk management

process

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

have a dedicated unit responsible for the risk management

process.

8. Credit risk The regulations as well as the supervisory framework cover the overall

credit risk process in terms of identification, management and mitigation.

9. Problem assets,

provisions, and

reserves

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

Core Principle Comments

banks to increase the level of provisions and reserves as well as banking

institutions financial strength via higher minimum capital requirements.

10. Large exposure

limits

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.

11. Exposure to

related parties

While the overall approach to connected lending is generally sound, the

exclusion of some significant minority shareholders is a gap that should be

addressed.

12. Country and

transfer risks

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.

13. Market risks 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.

14. Liquidity risk 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.

15. Operational risk 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

Core Principle 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.

16. Interest rate risk in

the banking book

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.

17. Internal control

and audit

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.

18. Abuse of financial

services

The assessors recommend AML/CFT Specialists join onsite BNM

supervisors for the examination of higher risk banks.

19. Supervisory

approach

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.

20. Supervisory

techniques

BNM has a strong and well structured supervisory program, using

appropriate supervisory techniques.

21. Supervisory

reporting

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.

22. Accounting and

disclosure

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.

Core Principle Comments

23. Corrective and

remedial powers of

supervisors

 Look to strengthen the legislative basis for the determination of non-

viability 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.

24. Consolidated

supervision

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.

25. Home-host

relationships

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.

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)

 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.

Licensing Criteria (CP3)

 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)

Transfer of Significant

Ownership (CP4)

 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.

Major Acquisitions

(CP 5)

 BNM should codify criteria 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.

Capital adequacy (CP6)

 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)

 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;

Risk Management

Process

(CP 7)

 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.

Large Exposures (CP10)  Fully use Pillar 2 to identify and assess credit concentrations;

Related Parties (CP 11)

 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

Country Risks (CP 12)  Introduce more explicit legal and regulatory requirements on banks in the

area of country and transfer risk.

Market Risk (CP 13)  Strengthen the supervisory framework by letting market risk specialist

participate in on site exams for higher risk institutions

Liquidity Risk

(CP 14)

 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.

Operational Risk

(CP 15)

 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.

Interest Rate Risk in the

Banking Book (CP 16)

 Release more detailed regulation and supervisory expectations in the

area of interest rate risk in the banking book.

 Implement Pillar 2 fully.

Abuse of Financial

Services (CP 18)

 Let AML/CFT specialists accompany supervisors during on site

examinations, particularly for high risk institutions.

Supervisory Approach

(CP 19)

 Increase the number and experience level of risk specialists and provide

for their spending more time in the field;

 Revisit methodology for assigning ratings to banks to provide capacity to

factor in more explicitly adverse effects from affiliates

Supervisory Reporting

(CP 21)

 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.

 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).

Accounting/Disclosure

(CP 22)

 Ensure clear communication to banks in case additional external audit

procedures are required.

Supervisors’ Corrective

and Remedial Powers

(CP 23)

 Look to strengthen the legislative basis for the determination of non-

viability 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.

Consolidated

Supervision (CP 24)

 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.

Home-Host

relationships (CP 25)

 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

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 on-

site 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 Home-

Host 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.

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).

5 The FSA bill was passed in December 2012.

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.

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.

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

6 The SC shares responsibility for investment banks with BNM.

currently regulates the nascent private sector pension fund industry using fund management

regulations; separate pension regulations are to be introduced soon.

49. Malaysia is undertaking comprehensive changes to its legislative framework for

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.

51. Pursuant to the Companies Act 1965, companies are required to prepare their

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.

52. Public interest entities are required to report their accounts using Financial

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.

53. Companies’ accounts are required to be audited annually by approved auditors.

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.

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 Comments

1. Objectives,

Powers and

Responsibilities

of the

Supervisor

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.

2. Supervisor 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.

The transparency of BNM’s regulatory expectations, and the process for

regularly reviewing their continued appropriateness, could be enhanced.

3. Information

Exchange and

Confidentiality

Requirements

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.

Insurance Core

Principle 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.

4. Licensing 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.

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.

5. Suitability of

Persons

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.

6. Changes in

Control and

Portfolio

Transfers

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.

Insurance Core

Principle 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.

7. Corporate

Governance

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.

8. Risk

Management

and Internal

Controls

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.

9. Supervisory

Review and

Reporting

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.

10. Preventative and

Corrective

Measures

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 Risk-

based 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.

11. Enforcement 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

Insurance Core

Principle Comments

enforcement decisions or actions.

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.

12. Winding-up and

Exit from the

Market

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.

13. Reinsurance

and Other

Forms of Risk

Transfer

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.

14. Valuation 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.

15. Investment 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.

16. Enterprise Risk

Management for

Solvency

Purposes

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.

17. Capital

Adequacy

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.

18. Intermediaries Under legislation, BNM is empowered to license, regulate and supervise

brokers and financial advisors. BMN conducts assessments of the

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.

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.

19. Conduct of

Business

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.

20. Public

Disclosure

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.

21. Countering

Fraud in

Insurance

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 anti-

fraud 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.

22. Anti-Money

Laundering and

Combating the

Financing of

Terrorism

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.

Insurance Core

Principle Comments

23. Group-wide

Supervision

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.

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.

24. Macroprudential

Surveillance and

Insurance

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.

25. Supervisory

Cooperation and

Coordination

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.

26. Cross-border

Cooperation and

Coordination on

Crisis

Management

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

Table 4. Recommendations to Improve Observance

of the

ICPs

Insurance Core

Principle

Recommendations

1. 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.

2. 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.

3. 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.

4. 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.

5. 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.

6. 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.

7. 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.

8. 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.

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.

9. Supervisory

Review and

Reporting

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.

Insurance Core

Principle

Recommendations

10. Enforcement 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.

Insurance Core

Principle

Recommendations

17. Intermediaries 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:

 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.

24. Supervisory

Cooperation and

Coordination

Recommendations on related matters of group-wide supervision and

information sharing considerations are addressed in assessments of other

ICPs.

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.

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 pre-

conditions 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).

8 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).

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

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

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.

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

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

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.

Table 5. Summary Implementation of the IOSCO Principles—Detailed Assessments

Principle Findings

1. The responsibilities of

the Regulator should be

clear and objectively

stated.

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.

2. The Regulator should

be operationally

independent and

accountable in the

exercise of its functions

and powers.

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.

3. The Regulator should

have adequate powers,

proper resources and the

capacity to perform its

functions and exercise its

powers.

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.

4. The Regulator should

adopt clear and

consistent regulatory

processes.

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.

5. The staff of the

Regulator should observe

the highest professional

standards, including

appropriate standards of

confidentiality.

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.

6. The Regulator should

have or contribute to a

process to monitor,

mitigate and manage

systemic risk, appropriate

to its mandate.

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.

Principle Findings

7. The Regulator should

have or contribute to a

process to review the

perimeter of regulation

regularly.

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.

8. The Regulator should

seek to ensure that

conflicts of interest and

misalignment of

incentives are avoided,

eliminated, disclosed or

otherwise managed.

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.

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.

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.

10. The Regulator should

have comprehensive

inspection, investigation

and surveillance powers.

The SC has broad inspection, investigation and surveillance powers.

11. The Regulator should

have comprehensive

enforcement powers.

The SC has broad powers to investigate and take action against anyone

who breaches the laws it administers.

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.

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.

Principle Findings

13. The Regulator should

have authority to share

both public and non-

public information with

domestic and foreign

counterparts.

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.

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.

The SC is a signatory to the IOSCO Multilateral MOU and to many

bilateral MOUs with its counterparties in other jurisdictions.

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.

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.

16. There should be full,

accurate and timely

disclosure of financial

results, risk and other

information that is

material to investors’

decisions.

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.

17. Holders of securities

in a company should be

treated in a fair and

equitable manner.

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.

Principle Findings

18. Accounting standards

used by issuers to

prepare financial

statements should be of a

high and internationally

acceptable quality.

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).

19. Auditors should be

subject to adequate levels

of oversight.

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.

20. Auditors should be

independent of the

issuing entity that they

audit.

There are extensive requirements for auditors to be independent of the

entities they audit and these requirements are enforced by the AOB.

21. Audit standards

should be of a high and

internationally acceptable

quality.

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.

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.

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.

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.

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.

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.

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.

Principle Findings

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.

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.

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.

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.

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.

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.

Principle 28. Regulation

should ensure that hedge

funds and/or hedge funds

managers/advisers are

subject to appropriate

oversight.

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.

29. Regulation should

provide for minimum entry

standards for market

intermediaries.

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.

30. There should be initial

and on-going capital and

other prudential

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

Principle Findings

requirements for market

intermediaries that reflect

the risks that the

intermediaries undertake.

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.

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.

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.

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.

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.

33. The establishment of

trading systems including

securities exchanges

should be subject to

regulatory authorization

and oversight.

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.

34. There should be on-

going 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

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.

Principle Findings

balance between the

demands of different

market participants.

35. Regulation should

promote transparency of

trading.

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.

36. Regulation should be

designed to detect and

deter manipulation and

other unfair trading

practices.

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.

37. Regulation should aim

to ensure the proper

management of large

exposures, default risk

and market disruption.

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.

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.

Not assessed

E. Summary Implementation and Recommended Action Plan

Table 6. Recommended Action Plan to Improve Implementation

the IOSCO

Principles

Principle Recommended Action

Principle 1 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.

Principle Recommended Action

Principle 2 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.

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

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.

10 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.

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.

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.

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

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

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.

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

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.

G. Summary of Compliance and Recommended Actions

Table 7. Summary of Compliance with the Deposit Insurance Core Principles

Principle Comments

1. Public Policy

Objectives (PPOs)

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.

2. Mitigating Moral

Hazard

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.

3. Mandate 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.

4. Powers 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.

5. Governance 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).

6. Relationship with

Other Safety Net

Participants

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.

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.

8. Compulsory

Membership

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.

9. Coverage 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.

10. Transitioning from

Blanket Guarantee

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.

11. Funding 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.

12. Public Awareness 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.

13. Legal Protection 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.

14. Dealing with Parties

at Fault

Relevant authorities have the power to seek legal redress against parties at

fault in a bank failure.

15. Early Detection and

Timely Intervention and

Resolution

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

Principle 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).

16. Effective Resolution

Processes

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.

17. Reimbursing

Depositors

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.

18. Recoveries 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.

Table 8. Recommended Action Plan—Deposit Insurance Core Principles

Principle Recommended Action

5.Governance 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).

8. Compulsory

Membership

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.

11. Funding 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.

13. Legal Protection PIDM should make coverage of former employees explicit in providing legal

protection for protected acts done in the course of their employment.

16. Effective Resolution

Processes

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.

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).

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.

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

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 time-

bound 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

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

13 Testing of default

management procedures

MyClear should introduce periodic testing of the

default management procedures and involve the

participants also.

11 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.

23 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.

1 The legal framework could

be strengthened to provide

explicit protection for the

collateral placed for intra-

day 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.

5 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.

17 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-of-

business day, unusual queue sizes, and high number

of requests for ICF etc. could be included in the BCP

testing.

Table 10. FMI Recommendations—BMDC

Principle

Issue of concern

and other gap or

shortcoming

Recommended action and comments

7 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.

13 Testing of default

management procedures

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.

14 Testing and validation of

segregation and portability

arrangements

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 time-

bound manner.

23 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.

1 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.

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.

17 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 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.

9 The settlement is currently

in commercial bank money.

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 11. FMI Recommendations—BMSC

Principles

Issue of concern

and other gap or

shortcoming

Recommended action and comments

4 The stress testing

methodology is inadequate

and the size of the clearing

guarantee fund is likely

inadequate as well.

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.

6 The BMSC CGF

mechanism does not fully

conform to the margin

requirement of the PFMI.

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 intra-

day basis.

7 There is no stress testing

model used for monitoring

liquidity risk.

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

13 Testing of default

management procedures

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.

14 Testing and validation of

segregation and portability

arrangements

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 time-

bound manner.

23 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.

1 The CMSA and the SCA do

not explicitly recognize

netting and novation. These

are however addressed in

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

Recommended action and comments

the default procedures

which have primacy in the

event of insolvency of a

participant.

empowering the BNM to declare the BMSC and

BMDC as designated payment systems.

12 The DVP arrangements

need to be tightened.

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.

17 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 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.

9 The settlement is currently

in commercial bank money.

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

11 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.

17 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.

23 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.

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

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

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)

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 on-

going 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.

Malaysia CR1353

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