Islamic Financial Services

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Bank Negara Malaysia (“BNM”) (Central Bank of Malaysia) has recently proposed standards and guidelines for sell and buy back agreements (“SBBA”) and collateralized commodity murabahah (“CCM”) transactions used as Islamic financial instruments in the Islamic Interbank Money Market (“IIMM”).

BNM’s exposure draft of 2 October 2023 sets out these proposals. Industry players have been asked to provide feedback by 31 October 2023, after which BNM will formalize a policy document on 1 January 2024.

The objectives of the policy document are to:

outline the scope of the SBBA and CCM transactions;
provide the regulatory requirements and BNM’s expectations for such transactions;
promote sound risk management practices for the conduct of such transactions; and
ensure compliance with Shariah principles.

Policy document will supersede previous guidance notes on SBBA

When it comes into effect, the policy document will supersede the Guidance Notes on Sell and Buy Back Agreement (“Guidance Notes”), previously issued on 28 June 2013.

The Guidance Notes provided best practices governing the conduct of the SBBA transaction. The SBBA, which is akin to the conventional repurchase (“Repo”) agreement, was modified to comply with Shariah principles and approved by the Shariah Advisory Council of BNM as an Islamic financial instrument.

A Repo agreement is guided by the Repurchase Agreement Transactions Policy Document issued by BNM in 2019. The policy document defines a Repo as a transaction which involves the sale of securities with a simultaneous agreement to repurchase them on a future date and at a higher price. The repurchase price consists of the original price plus an interest rate on the cash leg of the transaction.

In the SBBA, there are two distinct contracts which are concluded at two separate times, namely, the sale of securities in the first contract and the repurchase of the securities in the second contract. In addition, there is no stipulated condition to repurchase the securities by the seller in the first contract. The Wa’d or promise to repurchase and/or to sell the securities in the SBBA overcomes the inter-conditionality issue in the Repo, as the promise is only made upon the conclusion of the first contract.

The SBBA is thus the answer to a Shariah compliant repurchase agreement.

Policy document will enhance features and provide clarity in SBBA

The proposed policy document enhances the features of the existing SBBA transaction, namely by providing clarity to its definition and transaction sequence as follows:

an outright sale of SBBA securities by an SBBA seller to an SBBA buyer at an original price;
a promise, which may be in any of the following forms:
1. the SBBA seller unilaterally promises to buyback the same or equivalent SBBA securities from the SBBA buyer on a future date at a sale price;
2. the SBBA buyer unilaterally promises to sell the same or equivalent SBBA securities to the SBBA seller on a future date at a sale price; or
3. a bilateral promise by both the SBBA buyer to sell and the SBBA seller to buy back the same or equivalent SBBA securities on a future date at a sale price; and
an outright purchase of the same or equivalent SBBA securities by the SBBA seller from the SBBA buyer.

The element of promise or Wa’d in the SBBA arrangement prevents inter-conditionality between the sale and purchase transactions entered by the SBBA buyer and SBBA seller.

Key differences between the policy document and previous guidance notes

The key difference between the policy document and the Guidance Notes is the introduction of CCM as an alternative Islamic financial instrument for the IIMM. The CCM is an arrangement based on the Shariah principle of murabahah where a CCM pledgor buys commodity from a CCM pledgee on deferred payment terms. The CCM pledgor then pledges Shariah compliant securities as collateral for the deferred payment obligation under the murabahah contract.

Other salient differences between the Guidance Notes and the policy documents are set out below:

Conclusion

In 2014, the International Islamic Financial Market issued a Master Collateralized Murabahah Agreement (“MCMA”) which is a standard template used as an alternative to the Repo. The MCMA is based on the Shariah principles of murabahah and rahn and aims to address the issues and diversity in practices around the buying and selling of securities by the same counterparties at a future date.

Since then, international banking institutions, especially in the United Arab Emirates, have used the MCMA as a liquidity management tool.

Therefore, the introduction of CCM in this proposed BNM’s policy document may be more appealing to banking institutions that are less favourable towards the SBBA.

If you have any questions or require any additional information, please contact Lily Adelina Hashim, Raihan Naseeha Rafidi, or the Zaid Ibrahim & Co (in association with KPMG Law) partner you usually deal with.

This alert is for general information only and is not a substitute for legal advice.

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Islamic Financial Services

Malaysia's Central Bank issues Exposure Draft on Islamic Collateralised Funding

Bank Negara Malaysia recently proposed standards and guidelines for sell and buy back agreements and collateralized commodity murabahah transactions.