fstep manual investment banking final

First Edition April 2010

FINANCIAL SECTOR TALENT ENRICHMENT PROGRAMME

INVESTMENT BANKING HANDBOOK

2

2010 Institut Bank-Bank Malaysia

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medium by electronic means and whether or not transiently or incidentally to some other

use of this publication, without the written permission of the copyright holder. Written

permission must also be obtained before any part of this publication is stored in a retrieval

system of any nature. Application for permission should be addressed to Institut Bank-

Bank Malaysia.

Published by

Institut Bank-Bank Malaysia (35880-P)

Wisma IBI, 5 Ja;an Semantan

Damansara Heights, 50490 Kuala Lumpur

Tel: 603-20956833 (General Line),

603-20938803 (Qualifications), 603-20958922 (CPD)

Fax: 603-20952322 (General Line), 603-20957822 (CPD)

Website: www.ibbm.org.my E-mail: [email protected]

The development and production cost for

this handbook is subsidized by the

Staff Training Fund

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Foreword

The Financial Sector Talent Enrichment Program is an industry-driven post graduate

initiative of the financial services industry. Deriving from an idea promulgated by the

Governor of Bank Negara Malaysia, Tan Sri Dato Seri Dr Zeti Akhtar Aziz, FSTEP was established in September 2007 to address the shortage of skilled talents in the financial

services sector. The program aims to produce highly trained young professionals for the

financial services industry.

Banking in Malaysia is a fast-changing and dynamic industry with new

developments taking place all the time. The development the Malaysian domestic economy

would also need to change to a more productive structure that is more innovation-driven and

knowledge intensive. The role of the financial sector therefore will also evolve from being

an enabler of growth to becoming an important catalyst and driver of economic growth and

development. This will create increased demand for highly trained and competent

workforce to serve the financial industry. FSTEP therefore was established as part of the

overall talent development initiatives to contribute to the process of building and expanding

a sustainable pool of talent to best serve the present and future needs of the industry.

FSTEP occupies a unique niche within the financial services industry, providing a

training programme to equip participants with the essential knowledge and skills as well as

to nurture them to become well-rounded individuals to support the growth of the industry.

Through active collaboration of industry players, training modules were designed to blend

technical knowledge and personal development insight, which enables participants to

optimise their learning through a mix of classroom training based on case studies,

complemented by hands-on exposure through on-the-job training.

In writing this handbook, the author adopted an approach to comply with the

syllabus of the financial services stream, as outlined by FSTEP. As such, the handbook will

serve to augment the teaching and learning process to bring about maximum impact on the

participants of FSTEP. FSTEP participants should review the handbook material prior to

every class to expedite and maximize their understanding of the subject.

We wish to register our appreciation to IBBM, the author, the reviewer and many

others for the selfless contribution to this handbook and for their unwavering advice in

steering the handbook to successful completion.

FSTEP Management

March 22, 2010

Investment Banking

Authors: Amirullah Abdullah

Reviewer: Megat Othman Megat Shamsuddin

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Overview

The syllabus comprises the structure, functions, processes, products and services in the

investment banking sector. Discussions cover investment banking operations, compliance

and regulatory framework, fixed income securities, equity markets and stock broking

business, financial statement analysis, derivatives markets and risk management.

The personal development element focuses on developing appropriate skills and

competencies which are needed to apply the knowledge and dynamics of investment

banking, while the reality of site exposure to the business of investment banking is an

integral part of experiential learning.

Module Coverage

The goal of this module is to help participants to understand and apply the core contents of

investment banking and to assist them to do this efficiently and effectively.

Objectives

i. Describe the financial system in Malaysia, Financial Sector Master Plan, Capital Master Plan and the impacts of globalization on Malaysian banking industry.

ii. Discuss the role, structure, core activities and the key players in investment banking.

iii. Discuss the compliance and regulatory framework in investment banking; BNM Guidelines for Investment Banks, Securities Industry Regulations and Rules of

Bursa Malaysia Securities Berhad.

iv. Describe the types, elements and characteristic of fixed income securities issued by the public and private sector.

v. Understand and apply the concepts and techniques of Corporate finance, Mergers & Acquisitions , Divestitures.

vi. Apply the concepts of time value of money in pricing and valuation of fixed income securities.

vii. Discuss the elements and characteristics of shares and the equities market in which these investment instruments are traded.

viii. Describe the main operations of a stock broking company and the trading, clearing and settlement system of Bursa Malaysia Securities Berhad.

ix. Explain how financial ratios are used to evaluate the financial position and performance of a company.

x. Describe the top down approach to security analysis and the valuation of equity securities using the dividend discount model and the earnings multiplier model.

xi. Discuss the elements and characteristics of derivatives, particularly options and futures and the trading of these instruments in Malaysia.

xii. Explain the importance of risk management, and the role and responsibilities of the risk management unit within an investment bank.

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Module Outline

This module comprises eleven main topics:

Topic 1 Overview of the Banking Business

This topic provides the reader with an overview of the banking business. The function of the banking system is to ensure smooth flow of money from those who

have it [savers] to those who want to use it [borrowers], so that the latter can make

an effective use of the same, in the process benefiting themselves, the savers and the

economy as a whole.

Topic 2 Overview of Investment Banking

This topic introduces the reader to the role, structure and the core activities of investment banking. To put it simply, an investment bank acts as an intermediary,

and matches sellers of stocks and bonds with buyers of stocks and bonds. Other key

functions would be those of Corporate Finance and Debt capital market

Topic 3 Compliance and Regulations in Investment Banking

The purpose of this topic is to provide the reader with background information on the regulation of the investment banking industry. We will look at the key regulators

and the guidelines and legislation which affect investment banking.

Topic 4 Malaysian Fixed Income Securities

In this topic we shall discuss types of fixed income securities available in the market. A wide variety of debt securities products are available in the Malaysian

bond market, such as fixed coupon bearing bonds, asset-backed securities,

convertible bonds, callable bonds, etc.

Topic 5 Corporate Finance- Mergers and Acquisitions (M & A) & Divestitures

This topic will engage participants into the basics and key components of M & A and Divestitures. This module will also touch on the financing modes and the typical

processes.

Topic 6 Understanding Bonds

This topic describes the general characteristics of a bond and the risk associated with it. We will explain the mechanics of bonds valuation using the present value

concepts, the term structure of interest rates and the ratings of corporate bonds.

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Topic 7 Understanding Securities and Stock broking Business

In this topic we will provide the reader with an understanding of the stock broking business, one of the core components of investment banking. The main operations of

a stock broking company usually include dealing or trading, accounts and contract

departments because the stock broking business revolves around the buying and

selling of shares.

Topic 8 Malaysian Equity Markets

This topic discusses equity securities and the equity market in which these investment instruments are traded. Among others, we will discuss the structure of

the Malaysian equity markets, the concept of shares, the various equity hybrids and

the classification of shares for investment purposes.

Topic 9 Financial Statement Analysis

In this topic, we will describe three principal financial statements, namely the balance sheet, income statement and cash flow statement and discuss in detail the

use of financial ratios to assess company performance.

Topic 10 Valuation of Equities

In this topic, students shall be exposed to fundamental analysis, specifically the top down approach to analysis. We will illustrate the two commonly used methods to

equity valuation, i.e. the dividend discount model and the earnings multiplier model.

Topic 11 Understanding Derivatives Markets

This topic is aimed at providing the reader with an understanding of the concept and uses of derivatives, specifically the futures and options contract. Among others we

will discuss the role of derivatives and trading of options and futures in Malaysia

Topic 12 Risk Management in Investment Banking

In this topic we will discuss the types of risk faced by investment banks, the risk management system and the role and responsibilities of the risk management unit.

We will also provide the reader with the risk measurement techniques, specifically

the VAR and stress testing techniques.

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Table of Content

1 OVERVIEW OF BANKING BUSINESS

Preview - Topic Objectives 14

1.1 Introduction 15

1.2 Financial System - Constituents 16

1.3 Financial System of Malaysia 17

1.4 Banking System 17

1.5 Financial Markets 20

1.6 Importance of Banking Business to the Economy 20

1.7 Financial Sector Master Plan 21

1.8 Capital Market Master Plan 22

1.9 Impact of Globalization - Recent Developments 23

Summary 25

Activity Q&A 26

Suggested Answers to Activity 27

2 OVERVIEW OF INVESTMENT BANKING


2.1 Introduction 29

2.2 Commercial Banking Vs. Investment Banking 29

2.3 Establishment of Investment Banks in Malaysia 30

2.4 Role and Key Functions of Investment Banks 31

2.5 Overview of Core Activities of an Investment Banks 32

2.6 Roles and Responsibilities of the Middle Office 34

Summary 35

Activity Q&A 36


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Table of Content

3 COMPLIANCE AND REGULATORY FRAMEWORK IN INVESTMENT BANKING


3.1 Introduction 39

3.2 Bank Negara Malaysia 39

3.3 Securities Commission 41

3.4 Bursa Malaysia Securities Berhad 43

3.5 Securities Offences - Prohibited Conduct under the SIA 45

Summary 47

Activity Q&A 48


4 UNDERSTANDING BONDS


4.1 Introduction 51

4.2 Bonds Terms and Features 51

4.3 Risks in Bonds Investments 52

4.4 Bond valuation 54

4.5 Bond Yields 56

4.6 Price Yield Relationship 57

4.7 Term Structure of Interest Rates and Yield Curve 58

4.8 Ratings of Corporate Bonds 59

4.9 Bonds Issued by Foreign Entities 61

Summary 62

Activity Q&A 63


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Table of Content

5 MALAYSIAN MONEY AND DEBT MARKET SECURITIES


5.1 Introduction 67

5.2 Primary and Secondary Market for Dect Securities 67

5.3 Government Securities and Money Market Instruments 67

5.4 Money Market Instruments Issued by Banks and Financial Institutions 68

5.5 Private Debt Securities 69

Summary 73

Activity Q&A 74


6 UNDERSTANDING SECURITIES AND STOCKBROKING BUSINESS


6.1 History and Developments of Securities Industry in Malaysia 77

6.2 Functions of a Stockbroking Division 78

6.3 The Trading System 79

6.4 Clearing and Settlement 79

6.5 Central Depository System 81

6.6 Trading on Bursa Malaysia Securities Berhad 81

6.7 Financially Distressed Listed Companies 83

6.8 Outline of a Trade Trasaction 84

6.9 Account Structure 84

Summary 85

Activity Q&A 86


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Table of Content

7 MALAYSIAN EQUITY MARKET


7.1 Introduction 89

7.2 Basic Functions of a Stock Market 89

7.3 The Malaysian Stock Market 90

7.4 Types of Securities Traded on Bursa Malaysia Securities Berhad 90

7.5 Classifications of Shares for Investment Purposes 94

7.6 Participants in the Malaysia Equity Markets 95

Summary 96

Activity Q&A 97


8 UNDERSTANDING DERIVATIVES MARKETS


8.1 Introduction 100

8.2 General Description of Derivatives 100

8.3 The Role of Derivatives 103

8.4 The Main Players in the Derivatives Markets 104

8.5 Introduction to Futures 105

8.6 Introduction to Options 107

8.7 Regulatory Framework and Structure of The Malaysian Derivatives Markets 115

Summary 117

Activity Q&A 118


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Table of Content

9 CORPORATE FINANCE - MERGERS AND ACQUISITIONS (M&A) AND

DIVESTITURES



9.2 Initial Public Offering (IPO) 122

9.3 Mergers and Acquisitions 134

9.4 Divestitures 134

Summary 138

Activity Q&A 139


10 RISK MANAGEMENT IN INVESTMENT BANKING



10.2 What is Risk Management? 142

10.3 Classification of Risks 142

10.4 Risk Management - The process and system 142

10.5 Role and Responsibilities of the Risk Management Unit 145

10.6 Risk Management Techniques 146

10.7 Basel Capital Accord 149

Summary 150

Activity Q&A 151


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Table of Content

11 FINANCIAL STATEMENT ANALYSIS



11.2 Objectives of Financial Analysis 154

11.3 Financial Information 154

11.4 Financial Ratio Analysis 158

Summary 169

Activity Q&A 170


12 VALUATION OF EQUITIES



12.2 The Top Down Approach to Analysis 174

12.3 Basic Valuation Model 175

12.4 Price Earning (PE) Model 178

12.5 Measurement Investment Return 179

Summary 180

Activity Q&A 181


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Table of Content

APPENDIX

1 KLCI Futures Contract Specifications 185

2 Crude Palm Oil Futures Contract Specifications 186

3 KLIBOR Futures Contract Specifications 187

4 KLCI Options Contract Specifications 188

GLOSSARY

1 Glossary 189

REFERENCES

1 References 207

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Topic 1 Overview of Banking Business

Preview

This topic provides the reader with an overview of the banking business. The banking

system, comprising commercial banks, investment banks, and Islamic banks, is the primary

mover of funds and the main source of financing to support economic activities in Malaysia.

The non-bank financial intermediaries, comprising development financial institutions,

provident and pension funds, as well as insurance companies and takaful operators,

complement the banking institutions in mobilizing savings and meeting the financial needs

of the economy.

Topic Objectives

At the end of this topic, you should be able to:

i. Discuss the constituents of the financial system.

ii. Explain the structure of the financial system of Malaysia.

iii. List the objectives of Bank Negara Malaysia.

iv. Explain the main functions of commercial banks, investment banks, and Islamic banks.

v. Explain the importance of the banking business to the economy.

vi. Describe the Financial Sector Master Plan and Capital Market Master Plan.

vii. Discuss the impact of globalization on Malaysian banks.

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Overview of Banking Business

1.1 Introduction

A Bank is a familiar word and we all know that banks form an integral part of the very

financial system. So, to understand banks and banking, it is desirable to get a macro

perspective of the financial system as a whole. This leads us to the fundamental

question as to what constitutes the financial system.

The Financial System is a set or aggregation of institutions, instruments, markets and

services. A complex interplay of these components makes the financial system vibrant.

As with any other system, the financial system too has a paramount objective, i.e. to

ensure smooth flow of money from those who have it [savers] to those who want to use

it [borrowers], so that the latter can make an effective use of the same, in the process

benefiting themselves, the savers and the economy as a whole.

1.2 Financial System Constituents

Financial Institutions are engaged in the business of money or finance. They can be further classified into three categories:

i. Intermediaries

ii. Non-Intermediaries

iii. Regulatory Agencies

1.2.1 Intermediaries

Intermediaries are the financial institutions that accept deposits from the savers and

channel the same as lending/ investment to the users. In other words, financial

intermediaries function as a bridge between the savers and the users in any economy.

The financial intermediaries by their smooth conduit function make the economy infinitely more efficient in the usage of money.

Examples of financial intermediaries are:

i. Conventional Banks,

ii. Islamic Banks

iii. Investment Companies,

iv. Non-Banking Finance Companies [NBFCs],

v. Insurance companies,

vi. Mutual funds,

vii. Stock Brokerages,

viii. Credit Card Companies

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1.2.2 Non-Intermediaries

These are popularly known as Supranational. These institutions fund the users of

money, but, as a matter of policy, do not accept deposits from ordinary savers. They

get funds from their owners or members as capital contribution or subscription & not

from depositors.

Classic examples of such institutions are:

i. Asian Development Bank.

ii. World Bank.

iii. International Monetary Fund (IMF).

1.2.3 Regulatory Agencies

These are agencies whose sole function is to monitor and regulate the functioning of

the intermediaries and non-intermediaries and are referred to as Regulatory Authorities. They are like the traffic cops that lay down the Dos and Donts for the players in the market. To make their regulations enforceable, these agencies are

generally armed with punitive powers, which can be exercised in case of non-

compliance by any of the players.

Examples:

Banking Sector: In the Malaysian context, Bank Negara Malaysia is the

regulatory agency vis--vis the banking system. In US it is called the

Federal Reserve Bank. Capital Market: Financial regulators, such as the

U.S. Securities and Exchange Commission and in Malaysia, the Securities

Commission is responsible for regulating the capital market segment to

ensure that investors interests are protected.

1.3 Financial System of Malaysia

The Malaysian financial system is structured into two major categories:

1. Financial Institutions

The Financial Institutions comprise Banking System and Non-bank Financial

Intermediaries.

2. Financial Market.

The Financial Market in Malaysia comprises four major markets namely:

i. Money & Foreign Exchange Market, ii. Capital Market,

iii. Derivatives Market, and iv. Offshore Market.

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Sources: Bank Negara Malaysia

1.4 Banking System

The banking system consists of Bank Negara Malaysia (Central Bank of Malaysia),

banking institutions (commercial banks, investment banks and Islamic banks) and a

miscellaneous group (representative offices of foreign banks). The banking system is

the largest component of the financial system, accounting for about 67% of the total

assets of the financial system as at 2007.

The summary background information and functions of the banking institutions

mentioned above are set out as follows:-

Banking System 1. Bank Negara Malaysia 2. Banking Institutions

Commercial Banks

Investment Banks

Islamic Banks 3. Others

Representative

Offices of Foreign

Banks

Derivatives Market 1. Equity Derivatives 2. Commodity Derivatives

3. Financial Derivatives

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1.4.1 Bank Negara Malaysia (BNM)

Bank Negara Malaysia (the Central Bank of Malaysia) was established on 26 January

1959, under the Central Bank of Malaya Ordinance 1958. The objectives of BNM are

as follows:

i. To issue currency and keep reserves to safeguard the value of the currency;

ii. To act as a banker and financial adviser to the Government;

iii. To promote monetary stability and a sound financial structure; and

iv. To influence the credit situation to the advantage of Malaysia.

To meet its objectives, the Bank is vested with legal powers under various

laws to regulate and supervise the banking institutions and other non-bank financial

intermediaries. The Bank also administers the country's foreign exchange control

regulations and act as the lender of last resort to the banking system.

1.4.2 Financial Institutions

The following table provides and overview of the number of financial

institutions as at end-September 2008:

Table 1: Number of financial institutions as at end-September 2008:

Financial Institution Total

Malaysian -

Controlled

Institutions

Foreign -

Controlled

Institutions

Commercial Banks 22 9 13

Investment Banks 15 15 -

Islamic Banks* 15 10 5

International Islamic Banks 1 - 1

Insurers 41 25 16

Islamic Insurers (takaful operators) 8 8 -

International Takaful Operators) 1 - 1

Reinsurers 7 3 4

Islamic reinsurers (re-Takaful operators) 3 1 2

Development financial institutions 13 13 -

*Includes one foreign Islamic bank that commenced operations in October 2008


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1.4.3 Commercial Banks

The commercial banks are the largest and most significant providers of funds in the

banking system. The main functions of commercial banks are to provide:

i. Retail banking services such as the acceptance of deposit, granting of loans and advances, and financial guarantees;

ii. Trade financing facilities such as letters of credit, discounting of trade bills, shipping guarantees, trust receipts and Bankers Acceptances;

iii. Treasury services;

iv. Cross border payment services; and

v. Custody services such as safe deposits and share custody.

Commercial banks are also authorized to deal in foreign exchange and are the only

financial institutions allowed to provide current account facilities.

1.4.4 Investment Banks

Investment Banks are those that provide investment related services. They

do not provide direct credit as done by Commercial Banks.

The main activities rendered by an Investment Bank include:

i. Help companies, governments and their agencies to raise money by issuing and selling securities in the primary market.

ii. Assist public and private corporations in raising funds in the capital markets (both equity and debt).

iii. Provide financial services such as the trading of fixed income, foreign exchange, commodity, and equity securities and act as intermediaries in trading for clients.

iv. Underwrite" stock and bond issues and other types of financial transactions.

v. Operate as both brokerages and investment banks.

vi. Advice on mergers and acquisitions.

1.4.5 Islamic Banking

In Malaysia, separate Islamic legislation and banking regulations exist side-by-side

with those for the conventional banking system. The legal basis for the establishment

of Islamic banks was the Islamic Banking Act (IBA), which came into effect on 7

April 1983. The IBA provides BNM with powers to supervise and regulate Islamic

banks, similar to the case of other licensed banks.

As at 2008, Malaysia has seventeen full-fledged Islamic banks, three of which are

from the Middle East, providing a broad spectrum of financial products and services

based on Shariah principles. At the same time, there are seven conventional banks

three of which are major foreign banks, offering Islamic banking products and

services via the Islamic banking window set up.

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1.4.6 Non-bank financial intermediaries (NBFIs)

NBFIs complement the banking institutions in mobilizing savings and meeting the

requirements of specific economic sectors. These institutions also play an important

role in the development of the capital market and in providing social security.

Development financial institutions (DFIs), provident and pension funds, insurance

companies, takaful operators, savings institutions and unit and property trusts account

for the bulk of total assets of NBFIs.

1.5 Financial Markets

The Financial Markets mainly comprises:-

1) The Money and Foreign Exchange markets, and

2) The Capital and Derivatives Markets

1.5.1 The Money and Foreign Exchange markets

The money and foreign exchange markets are integral to the functioning of

the banking system, firstly, in providing funding to the banking system,

and secondly, serving as a channel for the transmission of monetary policy. These are

governed by the Malaysian Code of Conduct for Principals and Brokers in the

Wholesale Money and Foreign Exchange Markets in January 1994 which set out the

market practices, principles and standards to be observed.

1.5.2 The Capital and Derivatives Markets

The capital markets in Malaysia comprise the conventional and Islamic markets

for medium to long term financial assets. The conventional markets consist of two

main markets, namely the equity market dealing in corporate stocks and shares, and

the public and private debt securities.

Malaysia has a single derivatives exchange known as Bursa Malaysia Derivatives

Berhad (formerly known as Malaysian Derivatives Exchange or MDEX). This new

exchange which began on 11 June 2001 was the result of a merger by Malaysias two previous derivatives exchanges COMMEX (Commodity and Monetary Exchange

of Malaysia) and KLOFFE (Kuala Lumpur Option and Futures Exchange).

The Malaysian capital markets will be discussed in greater detail in later

topics.

1.6 Importance of Banking Business to the Economy

Economists and policy makers have recognized that finance has been widely

accepted as important prerequisite for sustaining long-run economic growth. Faster

growth, more investment and greater financial depth all come partly from higher

saving. For living standard to rise, a healthy flow of saving and investment must be

sustained.

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The economic functions of banks include:

1) Issue of money, in the form of banknotes and current accounts subject to cheque or

payment at the customer's order. These claims on banks can act as money because

they are negotiable and/or repayable on demand, and hence valued at par.

2) Netting and settlement of payments banks act as both collection and paying agents for customers, participating in interbank clearing and settlement systems

to collect, present, be presented with, and pay payment instruments.

3) Credit intermediation banks borrow and lend back-to-back on their own account as middle men.

4) Credit quality improvement banks lend money to ordinary commercial and personal borrowers (ordinary credit quality), but are high quality borrowers. The

improvement comes from diversification of the bank's assets and capital which

provides a buffer to absorb losses without defaulting on its obligations.

5) Maturity transformation banks borrow more on demand debt and short term debt, but provide more long term loans. In other words, they borrow short and

lend long.

1.7 Financial Sector Master Plan

BNM launched the Financial Sector Master Plan 2001 2010 on March 1, 2001. The objective of the plan is to develop a more resilient, competitive and dynamic

financial system with best practices, that supports and contributes positively to the

growth of the economy throughout the economic cycle, and has a core of strong and

forward looking domestic financial institutions that are more technology driven and

ready to face the challenges of liberalization and globalization.

The characteristics of the Financial Sector Master plan are as follows:

i. An increasingly more diversified financial sector that would meet the needs of a diversified economic structure. A competitive environment is likely to result in

banking institutions and insurance companies with differentiated strategies and

market niches.

ii. The insurance industry will be more dynamic and increase in size. A more liberalized environment will be created and the competition among local and

foreign insurance will be greater. This will bring down costs and premium, and

sizable increase in business volume.

iii. A more significant Islamic banking and Takaful industry with greater global orientation, with Malaysia positioned as the regional Islamic financial center.

iv. A focused set of development financial institutions, strengthened by the formulation of common rules and regulations.

v. A modern financial infrastructure supported by an efficient and effective payment system, a deep and liquid capital market and a strong consumer protection

framework.

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The implementation of the Financial Sector Master Plan for the banking sector is

summarized as follows:

Phase I

2001-2003

The main objective in the transition is to develop a core set of strong domestic

banking institutions. Therefore, initial steps shall focus on measures that seek

to strengthen the capability and capacity of domestic banking institutions,

create an environment where the best domestic banking institutions emerge,

and building and enhancing the financial structure.

Phase II

2004-2007

Following the initial phase in which domestic banking institutions have built

greater capacity and capability to compete, the playing field for incumbent

foreign players will increasingly be leveled. This will begin with the removal

of some of the restrictions on foreign players to add further competition to the

industry.

Phase III

After 2007

Given the intensifying degree of global competition and greater assimilation

into the global arena, the banking sector needs to be prepared for greater

liberalization. As a result, new foreign competitors will be introduced in the

third phase development.

1.8 Capital Market Master Plan

The Securities Commission revealed the Capital Market Master Plan 2001 2010 on February 22, 2001. The vision of the Malaysian Capital Market is to

be internationally competitive in all core areas necessary to support

Malaysias basic and capital investment needs, as well as its longer-term economic objectives.

The plan envisaged further liberalization of the stock broking industry, derivatives

market, investment management, equity and bond markets and Islamic capital market.

In order to achieve the vision, six key objectives have been identified to

form the basis for the Master plans main strategic initiatives and specific recommendations.

These objectives are as follows:

1. To be the preferred Fund-Raising center for Malaysian companies.

2. To promote an effective investment management industry and a more conducive environment for investors.

3. To enhance the competitive position and efficiency of market institutions.

4. To develop a strong and competitive environment for intermediation services.

5. To ensure a stronger and more facilitative regulatory regime.

6. To establish Malaysia as an International Islamic Capital Center.

The master plan contains a three-phase development plan for the 10-year period. It

starts with strengthening the capital markets, goes on to gradually deregulating and

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liberalizing, and progresses to expanding the depth and breadth of the markets. The

final goal is to build a capital market that is mature and internationally competitive.

The implementation of the Capital Market Master Plan can be summarized as follows:

2001 - 2003

Expand domestic capacity and strengthen the foundation for further

competition through progressive deregulation and selective liberalization,

with some relaxation of barriers to entry in certain nascent areas of the

capital market in order to accelerate development of these sectors

2004 - 2005

Progressively expand market access and gradually remove barriers to

entry across other capital market segments, and further develop the

breadth and quality of services and infrastructure

2005 - 2010

Implement further expansion plans towards becoming a mature capital

market and developing its international positioning in areas of

competitive and comparative advantage

1.9 Impacts of Globalization Recent Developments

1.9.1 What is Globalization?

Globalization means different things to different people. Generally, it refers

to an economic process that leads to increasing integration of economies

around the world. As a result of increased integration, there is increasing

economic interdependence among these economies through markets for goods,

services, and factors of production.

1.9.2 The Pros and Cons of Financial Globalization

Pros

i. To the emerging market economies like Malaysia, globalization allows them to further develop their capital markets by broadening and diversifying the

structure of national capital markets to include the development of tradable

securities. Such development complements the traditional role played by the

banking systems to meet financing needs of these economies. It also

encourages financial innovation and spurs economic growth.

ii. From the borrowers' perspective, financial globalization provides more choices of financial instruments which they can tap at competitive costs from a broader

range of providers. Therefore, firms can reduce their borrowing costs and

enhance their competitiveness.

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Cons

i. Financial markets have become more volatile and this poses a threat to financial stability, particularly to the banking system. The current financial

crisis which has translated into an economic crisis and its aftermath effects

(in terms of large output and welfare loss) supports this point.

ii. Globalization of the financial markets also results in excessive volatility of asset prices. The recent financial crisis showed that asset prices (such as

property prices, commodity prices and share prices) were overshot before they

burst. Worse still, they were substantially misaligned from economic

fundamentals for a relatively long period of time.

1.9.3 Recent Developments in Asia and the World

A key implication of globalization for the finance and capital market is that of

heightened global competition for business amid the increased cross-border

interaction and integration of markets and their participants. The emergence and

expansion of market economies, the removal of trade barriers, greater cross-border

interconnectivity, the spread of education and the impact of applied technology are all

increasing the degree of integration of global financial markets and competition

therein.

Over the last two decades, the emerging market economies, including Malaysia, have

become more integrated through financial markets. During this period, these

economies had introduced measures to gradually liberalize their financial markets,

following the successful pursuit of export-led industrialization in the 1970s and

1980s.

1.9.4 Liberalization of the Financial Sector

In Malaysia, the gradual but progressive liberalization of foreign exchange

administration rules undertaken since 2003 has led to significant benefits in terms of

providing enhanced flexibility of the financial sector, contributing to reducing the cost

of doing business as well as expanding the scope of activities of the financial sector.

In April 2009, several liberalization measures were implemented to further increase

international investors participation in the Malaysian capital market. These liberalizations measures are consistent with the objectives committed under the

Financial Sector Master Plan (FSMP) to develop a resilient, diversified and efficient

financial sector.

The liberalization package encompasses measures on the conventional and Islamic

finance sector as follows:

25

A. Issuance of New Licenses

i. Up to two new licensees will be offered to Islamic banking, commercial

banking and family takaful in 2009 to foreign players that will bring in

specialized expertise to address gaps in the financial sector and spur the

development of targeted economic sectors;

ii. Up to three new commercial banking licences will be offered in 2011 to world-

class banks that can offer significant value propositions to Malaysia;

B. Increase in Foreign Equity Limits

i. Existing domestic Islamic banks, investment banks, insurance companies and Takaful operators that wish to scale up their operations and expand into global

markets are given greater flexibility to enter into strategic partnerships with

foreign players through an increased foreign equity limit of up to 70%. For

Islamic banks, they will be required to maintain a paid-up capital of at least

USD1 billion;

ii. A higher foreign equity limit beyond 70% for insurance companies will be considered on a case-by-case basis for players who can facilitate consolidation

and rationalization of the insurance industry. Existing foreign insurers that

participate in the process will be accorded flexibility in meeting the divestment

requirement.

Summary

In this topic we have briefly provided an overview of the Malaysian Banking System. We

discussed the financial market intermediaries and briefly explained their functions and

importance to the economic development of the country.

The current forces of globalization, deregulation in the financial sector and the development

of information and communications technology are some of the factors leading to intense

competition faced by the financial markets of emerging economies. In an environment of

increasing liberalization and globalization, Malaysia is consistently assessing and reviewing

significant financial market developments and regulatory issues. The FSMP and CMMP has

been drawn up as a comprehensive blueprint for the Malaysian financial market and will

spearhead the reform and improvement needed to establish local and global credibility for

the countrys financial market.

26

Activity Q&A

1. Which of the following institutions is classified as a non-bank financial intermediary?

A. CIMB

B. MAYBANK

C. Bank Pembangunan

D. Affin Bank

2. The following are services rendered by a commercial bank, EXCEPT:

A. Custody services such as safe deposits and share custody.

B. Perform submissions on equity and bond issuances to the Securities Commission.

C. Trade financing facilities such as letters of credit and discounting of trade bills.

D. Retail banking services such as the acceptance of deposit and granting of loans.

3. Highlight three strategies to develop the financial sector in Malaysia. (You may

mention the strategies outlined in the Financial Sector Master plan.)

4. List three economic functions of banks.

27

Suggested Answers to Activity

1. C

2. B

3. Strategies to develop the financial sector as stipulated in the Financial Sector

Master plan is as follows (choose any three):

Building capacity with measures to enhance the capability of financial Institutions to

complete and become more efficient and effective.

Measures to promote stability.

Regulatory and institutional infrastructure would be further enhanced, while a more

efficient consumer protection framework would be instituted.

Gradual deregulation of the domestic financial market to bring about greater

Competition between various financial institutions.

Introduce new foreign competition and prepare the banking sector for greater

Liberalization. Expansion of domestic banking institutions to foreign markets, and

the potential threat from new and aggressive non-financial players would also

serve as an incentive for incumbent players to remain competitive.

4. The economic functions of banks include (choose any three):

Issue of money, in the form of banknotes and current accounts subject to cheque or payment at the customer's order. These claims on banks can act as money because

they are negotiable and/or repayable on demand, and hence valued at par.

Netting and settlement of payments banks act as both collection and paying agents for customers, participating in interbank clearing and settlement systems to collect,

present, be presented with, and pay payment instruments.

credit intermediation banks borrow and lend back-to-back on their own account as middle men.

Credit quality improvement banks lend money to ordinary commercial and personal borrowers (ordinary credit quality), but are high quality borrowers. The

improvement comes from diversification of the bank's assets and capital which

provides a buffer to absorb losses without defaulting on its obligations.

Maturity transformation banks borrow more on demand debt and short term debt, but provide more long term loans. In other words, they borrow short and lend long.

28

Topic 2 Overview of Investment Banking

Preview

This topic provides the reader with an overview of investment banking. The introduction of

investment banks in Malaysia is aimed at strengthening the capacity and capabilities of

domestic banking groups to contribute towards economic transformation and to face the

challenges of liberalization and globalization.

Topic Objectives

At the end of this topic, you should be able to

i. Discuss the differences between commercial banks and investment banks.

ii. Discuss the establishment of investment banks in Malaysia.

iii. List the key players in the local Investment Banking landscape.

iv. Describe the role and key functions of investment banks.

v. List the core activities of investment banks.

vi. Describe the structure of an investment bank.

29

Overview of Investment Banking

2.1 Introduction

British and European merchant banks had been a dominant force in the international

banking scene for a long time. However, there was a shakeout in the 1990s, and one by

one, many of these merchant banks started to drop out, either due to unsustainable

losses or as a result of industry consolidation. By the time the dust had settled, a clear

trend emerged - the European merchant banks had lost tremendous ground to the better

equipped US banks operating under the investment banking model.

Investment banks differ from commercial banks, which take deposits and make

commercial and retail loans. In recent years, however, the lines between the two types

of structures have blurred, especially as commercial banks have offered more

investment banking services. Investment banks may also differ from brokerages, which

in general assist in the purchase and sale of stocks, bonds, and mutual funds. However

some firms operate as both brokerages and investment banks. In Malaysia, all the

investment banks operate as both brokerages and investment banks.

2.2 Commercial banking vs. Investment banking

While regulation has changed the businesses in which commercial and investment

banks may now participate, the core aspects of these different businesses remain intact.

In other words, the difference between how a typical investment bank and a typical

commercial bank operates is simple: A commercial bank takes deposits for checking

and savings accounts from consumers while an investment bank does not. We'll begin

examining what this means by taking a look at what commercial banks do.

Commercial Banks

The typical commercial banking process is fairly straightforward. You deposit money

into your bank, and the bank lends that money to consumers and companies in need of

capital (cash). You borrow to buy a house, finance a car, or finance an addition to your

home. Companies borrow to finance the growth of their company or meet immediate

cash needs. Companies that borrow from commercial banks can range in size from the

dry cleaner on the corner to a multinational conglomerate.

Let's take a minute to understand how a bank makes its money:

On most loans, commercial banks earn interest anywhere from 5 to 14 percent. Ask

yourself how much your bank pays you on your deposits - the money that it uses to

make loans. You probably earn a paltry 1 percent on a current account, if anything,

and maybe 2 to 3 percent on a savings account. Commercial banks thus make lots of

money, taking advantage of the large spread between the interest paid on deposits (2

percent, for example) and their return on funds loaned (ranging from 5 to 14

percent).

30

Investment Banks

An investment bank in Malaysia operates with a slight difference. The Investment bank

is allowed to accept deposits of more than RM500, 000-00 and hence, also has an

inventory of cash deposits. It, however, does not lend as a business activity unless if

lending is linked to a capital market transaction (i.e. intermediate in nature, serving as a

bridging loan). In essence, an investment bank acts as an intermediary, and matches

sellers of stocks and bonds with buyers of stocks and bonds.

Note, however, that companies use investment banks toward the same end as they use

commercial banks. If a company needs capital, it may get a loan from a bank, or it may

ask an investment bank to finance equity or debt (stocks or bonds).

Investment banks typically sell public securities (as opposed private loan agreements).

Technically, securities such as Maybank stock or Genting AAA bonds, represent

government-approved stocks or bonds that are traded either on a public exchange or

traded-over-the-counter through an approved dealer. The dealer is the investment bank.

2.3 Establishment of Investment Banks in Malaysia

The framework on the creation for investment banks was introduced in 2005 following

the successful rationalization of commercial banks and finance companies. The

framework provided for the development of full-fledged investment banks through

consolidation, integration and rationalization between merchant banks, stock broking

companies and discount houses.

The establishment of investment banks would require the merchant banks, stock

broking companies and discount houses within the same banking groups to be

merged before the new entities are transformed into investment banks.

Discount houses which did not have merchant banks in their groups would also

merge with another discount house to become merchant banks, and subsequently be

transformed into investment banks when they merge with stock broking companies.

The integration exercise is aimed at:

i. Strengthening the capacity and capabilities of domestic banking groups to contribute towards economic transformation and developing a more resilient,

competitive and dynamic financial system to face the challenges of

liberalization and globalization;

ii. Enhancing their efficiency and effectiveness by minimizing duplication of resources and overlapping of activities, leveraging on common infrastructure and

reaping benefits of synergies and economies of scale.

iii. Strengthening their potential to capitalize on business opportunities, increase their competitive advantage and leverage on a larger capital base to support their

expanded range of activities. Customers will also benefit from wider access to

financial services at more cost-effective prices.

31

2.3.1 Key Players in the Local Investment Banking Landscape

As at December, 2008 there are 15 fully fledged Investment Banks in Malaysia. All the

banks are locally owned and they operate as brokerages and investment banks.

Table 2: List of Investment Banks in Malaysia

No. Investment Banks Ownership

1 Affin Investment Bank Berhad L (Local)

2 Alliance Investment Bank Berhad L

3 AmInvestment Bank Berhad L

4 CIMB Investment Bank Berhad L

5 ECM Libra Investment Bank Berhad L

6 Hong Leong Investment Bank Berhad L

7 Hwang-DBS Investment Bank Berhad L

8 KAF Investment Bank Berhad L

9 Kenanga Investment Bank Berhad L

10 Maybank Investment Bank Berhad L

11 MIDF Amanah Investment Bank Berhad L

12 MIMB Investment Bank Berhad L

13 OSK Investment Bank Berhad L

14 Public Investment Bank Berhad L

15 RHB Investment Bank Berhad L


2.4 Role and Key Functions of Investment Banks

Investment banks primarily have two functions.

i. Raising and investing capital.

They assist public and private corporations in raising funds in the primary

capital markets (both equity and debt). Investment banks primarily serve as

intermediaries between corporations or governments that want to attract

investment capital and investors wanting to invest capital. They also act as

intermediaries in trading for clients.

ii. Advising clients on strategic actions.

Investment banks assist with corporate reorganizations and advising on strategic

matters such as mergers & acquisitions, divestitures, corporate defense

strategies, joint ventures, privatizations, spin-offs and leveraged buyouts.

32

In the strictest definition, investment banking is the raising of funds; both in debt and

equity. However, only a few small firms in the world solely provide this service.

In Malaysia, all the investment banks are heavily involved in providing additional

financial services for clients, such as the trading of fixed income, foreign exchange,

and equity securities. It is therefore acceptable to refer to both the "Investment Banking

Division" and other 'front office' divisions such as "Fixed Income" as part of

"investment banking," and any employee involved in either side as an "investment

banker."

2.5 Overview of the Core Activities of an Investment Bank.

2.5.1 Corporate Finance

The bread and butter of a traditional investment bank, corporate finance

generally performs two different functions:

i) Mergers and acquisitions advisory

On the mergers and acquisitions (M&A) advising side of corporate finance,

bankers assist in negotiating and structuring a merger between two companies. If,

for example, a company wants to buy another firm, then an investment bank will

help finalize the purchase price, structure the deal, and generally ensure a smooth

transaction.

ii) Underwriting.

In this role, investment banks are financial intermediaries in securities offerings.

They verify financial data and business claims, facilitate pricing, and perform due

diligence. Most underwritings are firm commitment underwritings in which investment banks purchase the securities from the issuer and distribute them to the

public.

Services offered include:

i. Advising and preparing companies for floatation on the stock exchanges.

ii. Identifying potential merger partners and take-over targets for clients and advising on mergers and acquisitions and take-over transactions.

iii. Devising and executing strategies for capital raising activities through placement of securities, secondary issues of securities, special issues,

convertible loans and other capital market instruments.

iv. Providing advice from corporate restructuring exercises to restructure a companys gearing or business operations.

v. Offering independent evaluation of corporate transactions and valuation of companies/business/securities and assets.

33

2.5.2 Debt Capital Markets.

The debt capital markets department provides the investment banks corporate clients

with the expertise in structuring debt financing programs via debt securities

instruments, conventional or Islamic.


i. Advising and arranging for the issuance of debt securities.

ii. Underwriting the issuance of debt securities.

iii. Subscribing the issuance of debt securities.

iv. Placement of debt securities.

v. Agency role throughout the tenure of the debt securities.

2.5.3 Equity Markets/Stock broking.

The Equity Capital Markets department manages the investment banks activities in the

primary and secondary equity and equity-linked markets. Equity Capital Markets

assists companies in accessing the equity capital market for their financing

requirements.


i. Arranging, structuring and underwriting a of an equity issuance.

ii. Placement of stock and shares.

iii. Trading of stock and shares.

iv. Advising on investment activities.

v. Custody and nominee services.

2.5.4 Derivatives and Structured Products.

Derivatives and Structured Products has been a relatively recent division as derivatives

have come into play, with highly technical and numerate employees working on

creating complex structured products which typically offer much greater margins and

returns than underlying cash securities.


i. Advising, originating and issuing of products/structures.

ii. Designing products/structures with modified risk-return profiles.

34

2.5.5 Treasury.

Authorized to accept call deposits and fixed term deposits. The Treasury division

engages in proprietary trading in money market and fixed income instruments.


i. Accepting deposits from wholesale customers (RM500,000 and above).

ii. Buy and sell Money Market instruments.

iii. Buy and sell Debt capital Market instruments.

2.5.6 Research.

Research analysts follow stocks and bonds and make recommendations on whether to

buy, sell, or hold those securities. Stock analysts (known as equity analysts) typically

focus on one industry and will cover up to 20 companies' stocks at any given time.

Some research analysts work on the fixed income side and will cover a particular

segment, such as high yield bonds or Malaysian Government Securities. Salespeople

within the I-bank utilize research published by analysts to convince their clients to buy

or sell securities through their firm. Corporate finance bankers rely on research

analysts to be experts in the industry in which they are working. Reputable research

analysts can generate substantial corporate finance business as well as substantial

trading activity, and thus are an integral part of any investment bank.

2.6 Roles and Responsibilities of the Middle Office and Back Office Departments.

2.6.1 Middle Office.

The main function of the Middle Office is Risk Management which involves

analyzing the market and credit risk that traders are taking onto the balance sheet in

conducting their daily trades, and setting limits on the amount of capital that they are

able to trade in order to prevent 'bad' trades having a detrimental effect to a desk

overall.

Another key Middle Office role is to ensure that the above mentioned financial risks

are captured accurately (as per agreement of commercial terms with the counterparty)

correctly (as per standardized booking models in the most appropriate systems) and on

time (typically within 30 minutes of trade execution). In recent years the risk of errors

has become known as "operational risk" and the assurance Middle Offices provide now

include measures to address this risk. When this assurance is not in place, market and

credit risk analysis can be unreliable and open to deliberate manipulation.

35

2.6.2 Back Office

i. Operations

This is where the operational activities of the investment bank take place.

Operations involve data-checking trades that have been conducted, ensuring that

they are not erroneous, and transacting the required transfers. While it provides the

greatest job security of the divisions within an investment bank, it is a critical part

of the bank that involves managing the financial information of the bank and

ensures efficient capital markets through the financial reporting function. The staff

in these areas need to understand in depth the deals and transactions that occur

across all the divisions of the bank.

ii. Technology

Every major investment bank has considerable amounts of in-house software,

created by the Technology team, who are also responsible for Computer and

Telecommunications-based support. Technology has changed considerably in the

last few years as more sales and trading desks are using electronic trading

platforms. These platforms can serve as auto-executed hedging to complex model

driven algorithms.

Summary

In this topic we have provided the reader with an overview of investment banking. We

started by explaining the difference between commercial banks and investment banks. We

then discussed the framework for investment banks in Malaysia and briefly explained their

role and functions. We end this topic by describing the core activities and the typical

structure of and investment bank.

36

Activity Q&A

1. The following are services rendered by an investment bank, EXCEPT:

A. Assist public and private corporations in raising funds in the capital markets.

B. Underwrite" stock and bond issues and other types of financial transactions.

C. Trade financing facilities such as letters of credit and discounting of trade bills.

D. Advice on mergers and acquisitions.

2. The following are services offered by the Treasury division of an investment bank,

EXCEPT:

A. Accepting deposits from wholesale customers (RM500, 000 and above).

B. Buy and sell Money Market instruments.

C. Advise on mergers and acquisitions.

D. Buy and sell Fixed Income securities.

3. Describe the role and key functions of investment banks.

4. Explain the rationale for the integration of merchant banks, stock broking companies and

discount houses into investment banks.

37


1. C

2. C

3. Investment banks primarily have two functions.

Raising and investing capital.

They assist public and private corporations in raising funds in the primary and

secondary capital markets (both equity and debt). Investment banks primarily serve as

intermediaries between corporations or governments that want to attract investment

capital and investors wanting to invest capital. They also act as intermediaries in trading

for clients.

Advising clients on strategic actions.

Investment banks assist with corporate reorganizations and advising on strategic matters

such as mergers & acquisitions, divestitures, corporate defense strategies, joint ventures,

privatizations, spin-offs and leveraged buyouts.

3. The integration exercise is aimed at:

strengthening the capacity and capabilities of domestic banking groups to contribute towards economic transformation and developing a more resilient, competitive and

dynamic financial system to face the challenges of liberalization and globalization;

enhancing their efficiency and effectiveness by minimizing duplication of resources and overlapping of activities, leveraging on common infrastructure and reaping benefits of

synergies and economies of scale.

Strengthening their potential to capitalize on business opportunities, increase their competitive advantage and leverage on a larger capital base to support their expanded

range of activities.

38

Topic 3 Compliance and Regulatory Framework in Investment Banking

Preview

The purpose of this topic is to give you background information that provides you with a

feel for the regulation of the investment banking industry as well as the key regulators. The

investment banking industry is governed by several different pieces of legislation to ensure

orderly markets and encourage investment.

Topic Objectives

At the end of this topic, you should be able to

i. Discuss the key features of the BNM Guidelines for Investment Banks.

ii. Describe the role and functions of the SC.

iii. List the sources of securities law.

iv. Describe The Capital Markets and Services Act 2007 (CMSA).

v. Discuss the role and duties of the stock exchange.

vi. Relate the conduct of business by participating organizations in relation to The Rules of Bursa Malaysia Securities Berhad.

vii. Discuss the areas covered by the Rules of Bursa Malaysia Securities Berhad in relation to trading by the participating organizations.

39

Compliance and Regulatory Framework in Investment Banking.

3.1 Introduction

Developments in the global financial markets over the recent years have placed great

scrutiny on the effectiveness of regulatory and supervisory oversight regimes around

the world. These recent events have emphasized the crucial need for sound regulatory

and supervisory frameworks which keep pace with the rapidly evolving financial

landscape.

Investment banks in Malaysia are co-regulated by Bank Negara Malaysia and the

Securities Commission. They hold two licenses issued pursuant to the Banking and

Financial Institutions Act 1989 and the Securities Industry Act 1983 respectively. In

carrying out their duties, Bank Negara Malaysia and the Securities Commission adopt

an objective-driven approach to maximize efficiency and effectiveness in regulating

investment banks.

3.2 Bank Negara Malaysia.

Bank Negara Malaysia regulates the activities of financial institutions through the

Banking and Financial Institutions Act, 1989 (BAFIA) which was enacted to provide

laws for the licensing and regulation of institutions carrying on banking, financing and

investment banking activities.

3.2.1 Banking and Financial Institutions Act, 1989 (BAFIA).

The Banking and Financial Institutions Act, 1989 (BAFIA) was passed in Parliament

and came into force on October 1, 1989. The BAFIA has effectively replaced the

Banking Act 1973 and the Finance Companies Act 1969. The Islamic Banking Act

1983, however, is not affected.

3.2.2 The Anti-Money Laundering and Anti-Terrorism Financing Act 2001 (AMLAFA).

Money laundering is a process by which proceeds derived from criminal / illegal

activities are converted to legitimate funds. It embodies all transactions that disguise,

conceal or impede the establishment of the illegal origins, location or ownership of the

funds.

Money laundering can be carried out in three stages:

a. Placement : The money launderer disposes cash proceeds derived from illegal activities e.g. using illegal funds to settle a loan in cash.

b. Layering : The money launderer separate illegal proceeds from the source through transactions that disguises audit trail and provide anonymity

c. Integration: The money launderer returns the proceeds to the economy as normal business funds.

The Anti-Money Laundering and Anti-Terrorism Financing Act 2001 (AMLAFA) was

gazetted on 5 July 2001. AMLAFA provides comprehensive new laws for the

40

prevention, detection and prosecution of money laundering, the forfeiture of property

derived from, or involvement in money laundering and the requirements for record

keeping and reporting of suspicious transactions for reporting institutions.

AMLAFA addresses the following broad issues:-

i. Money laundering offences.

ii. Financial Intelligence Unit.

iii. Reporting obligations.

iv. Powers of investigation, search and seizure.

v. Powers of freezing, seizure and forfeiture of property.

3.2.3 BNM Guidelines on Investment Banks

The Guidelines on Investment Banks (the Guidelines) were issued jointly by BNM and

the SC pursuant to Section 126 of the Banking and Financial Institutions Act 1989

(BAFIA) and Section 158 of the Securities Commission Act 1993 (SCA). It sets out the

requirements and processes for the setting up of the investment bank and the regulatory

framework within which the investment bank would operate.

I. Key Features of the Regulatory and Supervisory Framework for Investment

Banks in Malaysia.

Dual regulation and supervision by Bank Negara Malaysia and the Securities

Commission.

Clear accountabilities minimize regulatory gaps and overlaps

i. Arrangements formalized under a Memorandum of Understanding between the two agencies ensure that responsibilities are unambiguous

and well-defined.

ii. Bank Negara Malaysia is responsible for the prudential regulation of investment banks to ensure their safety and soundness and the overall

stability of the financial system.

iii. The Securities Commission is responsible for the investment banks business and market conduct in order to promote market integrity and

investor protection in the capital market.

iv. Cohesive arrangements facilitate prompt and decisive action by the two agencies.

v. Similar regulatory and supervisory regime to commercial banks

Prudential regulation of investment banks

i. Investment banks are subject to prudential requirements, which are similarly applied to commercial banks, including Basel II, limits on

41

exposures to single counterparties, connected lending restrictions and

corporate governance standards.

Supervisory and surveillance framework

i. Comprehensive and holistic risk assessments are conducted on the investment banks businesses and overall health, including the conduct of on-site examinations.

ii. Enables early detection and pre-emptive action to be taken to address emerging risks and vulnerabilities in individual investment banks.

iii. Banking groups that have both commercial banks and investment banks are supervised on a consolidated basis to enable comprehensive

assessments of their safety and soundness. Bank Negara Malaysia is also

organized internally to support such oversight, with a dedicated

department supervising financial conglomerates.

II. Scope of Activities

i. Investment banks will retain all activities based on the types of licenses they held prior to the rationalization. Investment banks will therefore

continue to accept wholesale deposits; conduct lending activities to

complement their fee based activities and provide a wide array of

investment banking activities which include, amongst others, financial

advisory, underwriting, portfolio management and equity brokerage

services.

III. Minimum Capital Requirements

i. To ensure that investment banks are well-capitalized, the minimum capital funds requirement for investment banks that are not part of

banking groups will be set at RM500 million, while the other investment

banks would be required to comply with the requirement of RM2 billion

on a group basis.

3.3 Securities Commission

The Securities Commission (SC) is a statutory body entrusted with the responsibility

of regulating and systematically developing Malaysias capital markets. It has direct responsibility in supervising and monitoring the activities of market institutions and

regulating all persons licensed under the Capital Markets and Services Act 2007

(CMSA).

Its main roles under the Securities Commission Act 1993 are:

i. To act as a single regulatory body to promote the development of capital markets;

ii. To take responsibility for streamlining the regulations of the securities market, and for speeding up the processing and approval of corporate transactions.

42

iii. To promote and maintain fair, efficient, secure and transparent securities and futures markets; and to facilitate the orderly development of an innovative and

competitive capital market in Malaysia.

Among SC's many regulatory functions include:

i. Registering the prospectuses for all securities except those issued by unlisted recreational clubs;

ii. Regulating all matters relating to securities and futures contracts;

iii. Regulating the take-over and mergers of companies;

iv. Regulating all matters relating to unit trust schemes;

v. Licensing and supervising all licensed persons;

vi. Supervising exchanges, clearing houses and central depositories; and

vii. Encouraging self-regulation and ensuring proper conduct of market institutions and licensed persons.

3.3.1 Sources of Securities Law

The legislation, which affects the securities industry, is as follows:

i. Securities Commission Act 1993 (SCA).

ii. Capital Markets and Services Act 2007 (CMSA)

iii. Securities Industry (Central Depositories) Act 1991 (SICDA).

iv. Companies Act 1965 (CA).

3.3.2 Capital Markets and Services Act 2007 (CMSA)

The Capital Markets and Services Act 2007 (CMSA) repeals the Securities Industry

Act 1983 (SIA) and the Futures Industry Act 1993 (FIA). The CMSA which takes

effect on 28 September 2007 introduces a single licensing regime for capital market

intermediaries.

Under this new regime, a capital market intermediary will only need one license to

carry on the business in any one or more of the following regulated activities:

i. Dealing in securities;

ii. Trading in futures contracts;

iii. Fund management;

iv. Advising on corporate finance;

v. Investment advice; and

vi. Financial planning.

Licensing ensures an adequate level of investor protection, including the provision of

sufficient safeguards to protect investors from default by market intermediaries or

problems arising from the insolvency of such intermediaries. More importantly, it

43

instills confidence among investors that the organizations and people they deal with

will treat them fairly and are efficient, honest and financially sound.

The chart on the next page highlights the structure of the securities regulatory system

in Malaysia.

Chart 2: Structure of the Securities Regulatory System in Malaysia.

Sources: Securities Commission.

3.4 Bursa Malaysia Securities Berhad.

Bursa Malaysia Securities Berhad, like other exchanges, was developed to meet two

basic and complementary needs: a business need for raising funds, and an individuals or companys desire to invest saving efficiently.

The duties of the stock exchange are set out in S.11 of the Capital Markets and

Services Act 2007 (CMSA) and include the following:

i. It shall be the duty of the stock exchange to ensure, so far as may be reasonably practicable, an orderly and fair market for securities that are traded through its

facilities.

SCA

CMSA Companies Commission

Of Malaysia.

Companies Act 1965

SC

Bursa Malaysia Securities Bhd.

Bursa Malaysia Depository Sdn.

Bhd.

Bursa Malaysia

Derivatives Bhd.

Bursa Malaysia

Derivatives Clearing Bhd.

BhdBhd

Bursa Malaysia

Securities Clearing Bhd.

Bhd

Labuan International

Financial Exchange Inc.

44

ii. In performing this duty, the stock exchange shall:

- act in the public interest and ensure that where any interest that is required to be served under any law relating to corporations conflict with the

interest of the public, the latter shall prevail.

- ensure that the participants of the stock exchange, participating organizations and corporations whose securities are listed on the stock

exchange comply with the rules of the stock exchange that apply to such

participant, participating organization or corporations.

A stock exchange must provide adequate and properly equipped premises for the

conduct of its business; competent personnel for the conduct of its business and

automated system with adequate capacity, security arrangements and facilities to meet

emergencies.

As a participating organization of Bursa Malaysia Securities Berhad the conduct of

business by investments banks shall be governed by the Rules of Bursa Malaysia

Securities Berhad (Chapter 4) which addresses the following:

i. Prohibition against unapproved sales methods (such as share hawking) and advertising of securities for sale or purchases Rule 401.1(1)(a).

ii. Dealing only with other participating organizations or a participant of another recognized stock exchange Rule 401.1(1)(d).

iii. Prohibition on advertising except in the manner approved or determined by Bursa Malaysia Securities Berhad Rule 401.2(1).

iv. Prohibition against employing a former participant who committed a default under the Rules of Bursa Malaysia Securities Berhad or securities laws or was

expelled from participation Rule 401.1(1)(g).

v. Not engaging in or being a party to unlawful practices Rule 401.1(1)(f).

vi. Refraining from engaging in or being a party to any unethical practices that may damage the confidence of investors and hamper the sound development of

the stock market Rule 401.1(20).

In relating to trading, the Rules of Bursa Malaysia Securities Berhad also covers the

following areas:

i. Automated trading system (Rule 701).

ii. Transactions by employees and directors of participating organizations (Rule 7020).

iii. Complaints (Rule 403.2).

iv. Dealing in securities (Rule 601).

v. Delivery and settlement (Chapter 8).

vi. Fees and charges including brokerage, SC levy, clearing fees and a system maintenance fees (Chapter 10).

45

vii. Dealers representatives (Rule 310).

viii. Penalties in relation to conduct by dealers representatives (Chapter 13).

The penalties for non-compliance with the Rules of Bursa Malaysia Securities Berhad

include fines, suspension or expulsion of participating organizations and reprimand,

fine, suspension of right to trade, having name struck off the register or having

restriction placed on activities relating to functions for dealers representatives (Rule 1304)

3.5 Security Offences Prohibited Conduct under the CMSA

The following are some of the conducts prohibited under the CMSA:-

(1) Short Selling

Short selling is the practice whereby the seller sells securities which, at the date of the

agreement for sale, it does not own but intends to acquire before the delivery date. The

seller that engages in short selling is relying on the market price of the securities

dropping between the date of the sale contract and the date for delivery under that

contract, thus providing a profit. Naturally, short selling is more prevalent in a bear

market where the odds of such a decline in price are considerably better than in a bull

market.

The danger of short selling from the securities market point of view is that the seller

may be unable to purchase the securities in time for delivery and will therefore default

on the contract.

Section 98 of CMSA prohibits a person from selling securities to a purchaser unless at

the time of the sale, the person (or their agent) has presently exercisable and

unconditional right to vest the securities in the purchaser.

The CMSA, however, also sets out a limited number of circumstances in which short

selling is permitted and note these exceptions, particularly in relation to-

i. Odd lots.

ii. Pre-existing contract for purchase conditional only upon payment or receipt

of transfer or title money market.

iii. Securities as prescribed by the Minister.

iv. Securities of a class designed by Bursa Malaysia Securities Berhad where the sale is made in accordance with the Rules of Bursa Malaysia Securities Berhad.

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(2) False Trading and Market Rigging Transactions

S.175 (1) of the CMSA prohibits a person from creating; causing to be created or

doing anything that is calculated to create-

i. A false or misleading appearance of active trading of.

ii. A false or misleading appearance with respect to the market for.

iii. a false and misleading appearance of the price of,

iv. Any securities on a stock market in Malaysia.

S.175(3) provides that a person shall be deemed to have created a false or misleading

appearance of active trading if such person has entered into a transaction where there

is no change in the beneficial ownership or where it has prearranged the transaction.

(3) Stock Market Manipulation.

S.176(1) of the CMSA prohibits a person from entering into transactions that have or

are likely to have the effect of raising, lowering or pegging, fixing, maintaining or

stabilizing the price of securities for the purposes which may include inducing others to

acquire or dispose of the securities of the corporation or related corporation.

A transaction includes unexecuted bids and offers. This is irrespective of whether another person is included.

(4) False or Misleading Statement in Relation to Securities.

A person must not make a statement or disseminate information that is false or

misleading in a material particular and

i. is likely to induce the sale or purchase of securities by other persons.

ii. is likely to have the effect of raising or lowering, maintaining or stabilizing the market price of securities,

iii. When he or she makes or disseminates it, the person

Does not care whether the statement or information is true or false, or knows or

ought to reasonably know that it is false or misleading.

(5) Fraudulently Inducing Persons to Deal in Securities

It is an offence to induce or to attempt to induce another person to deal in securities

by-

i. Making or publishing any statement, promise or forecast that the maker knows to be misleading, false or deceptive.

ii. Dishonestly concealing material facts.

iii. Recklessly making or publishing dishonestly or otherwise any statement of promise or forecast that is misleading, false or deceptive.

iv. Recording or storing in, or by means of any mechanical, electronic or other device information that the maker knows to be false or misleading in a material

particular.

47

Persons who are subjected to his prohibition include officers of a company in relation

to a company prospectus or to a stock broking company advising clients about an issue

or sale of securities.

(6) Insider Trading

The rationale for prohibiting insider trading includes the following:

i. Fairness and transparency in the market place, equal access to information for all market participants.

ii. Market integrity.

iii. Corporate disclosure and good corporate governance.

iv. Prevention of injury to the company, its shareholders and investor.

Those who trade on privileged or price-sensitive information to make quick profits in

the market are said to be profiteering at the expense of those who do not have access to

the same inside information. Those occupying privileged positions may hoard

information or keep it away from the public because they feel or they know that once

the information is made public, it will cause the price of the shares issued by the

company to rise or fall. By keeping this information to themselves, they make large

profits by buying or selling the stock before its price rises or they may protect

themselves by selling stock before its price falls. If the information was made freely

available, then they would not have had the unfair advantage.

Summary

This topic is intended as a brief introduction, by way of providing an overview of the

compliance and regulation of investment banks in Malaysia. We started by looking at the

key features of the BNM Guidelines on Investment Banks before briefly considering the

functions of the SC and the legislation which affects the securities industry.

We then briefly examined the areas covered by the Rules of Bursa Malaysia Securities

Berhad in relation to the conduct of business and trading of the participating organizations.

We end this topic by looking at the various security offences and prohibited conduct under

the SIA

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Activity Q&A

1. All of the following are true, EXCEPT:

A. Investment banks will hold two licenses, issued pursuant to Section 5 of BAFIA

and Section 64 of the CMSA respectively.

B. Investments banks are allowed to accept deposits subject to a minimum amount of

RM500.000.

C. Bank Negara Malaysia regulates the activities of financial institutions through the

Banking and Financial Institutions Act, 1989 (BAFIA).

D. SC will be responsible for the approval of the appointment and reappointment of

directors and CEOs of investment banks.

2. Which of the following is NOT a source of securities law?

A. Securities Commission Act 1993 (SCA).

B. Capital Markets and Services Act 2007 (CMSA).

C. Banking and Financial Institutions Act, 1989 (BAFIA).

D. Securities Industry (Central Depositories) Act 1991 (SICDA).

3. The entire following are conducts prohibited under the SIA, EXCEPT:

A. Stock market manipulation.

B. Short selling.

C. Buying-In.

D Market rigging.

4. List three regulatory functions of the SC.

5. What is the danger of short selling from the securities market point of view?

49


1. D

2. C

3. C

4. SC's regulatory functions (choose any three):

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