The world is becoming more interconnected and diversified, and corporations are looking across borders to take advantage of business opportunities. FARHAH HAYATI MAMAT and WHALAN KAZOMBIAZE discuss the importance of cross-border funding to the development of the Islamic finance industry.
Emerging countries are the new markets where raw materials, cheap labor, energy sources and low-cost goods are to be found. Efficient access to capital is a critical impetus of many transactions and in many cases local banks or credit markets in these countries are unable to satisfy all capital requirements of companies with multinational interests or aspirations.
The formation of capital is increasingly viewed and accomplished on a worldwide basis. Global cross-border capital flows which include lending, foreign direct investment, and equity and bond purchases reached US$4.6 trillion in 2012. In the same year, 32% of total foreign capital flowed into developing economies, while capital flowing out of emerging markets rose to US$1.8 trillion. Generally financial institutions serve as the main source of financing.
Before issuing any sort of commitment letter to the customer for the provision of finance, a financier considering undertaking a cross-border financing facility will need to address the following issues:
Tax considerations
A financier wishing to provide cross-border financing will need to determine whether:
(i) Extending financing to a customer incorporated in another jurisdiction will subject the financier to any taxes in that jurisdiction;
(ii) The jurisdiction where the customer is located will impose withholding tax on the amount of profit to be paid in connection with the financing; and
(iii) The financier has to make any other payments or deposits, such as mandatory deposit requirements with the central bank of the jurisdiction where the customer is located.
(i) Dividends;
(ii) Interest/profit;
(iii) Royalties; and
(iv) Fees for technical services.
In a financing transaction, the interest payment of each financing payment payable by the customer to financier is subject to a prescribed withholding tax rate based on 15% withholding rate (or any other rate as prescribed under the double taxation agreement between Malaysia and the country where the non-resident person/payee is tax resident):
Stamp Duty
The Stamp Act of 1949 provides that stamp duty shall be paid by the person offering the security or having financing services from the financier. If the financing structure involved foreign currency transaction, the stamp duty payable on the primary instrument will be not more than RM500 (US$153.13). Stamp duty must be paid within 30 days from date of the agreement or from the date the executed agreement is brought into Malaysia.
The requirement for the stamping is to ensure the admissibility of the financing documentation before the courts of Malaysia.
Licensing requirements
If the financier is not licensed to carry on business in the customer’s jurisdiction, the financier has to analyze whether the provision of financing from abroad would be deemed by the laws of the customer’s jurisdiction as carrying on business, and if so, whether the financier needs to obtain any licenses or agency authorizations. Other licensing or required approvals considerations, is in cases where the officers of the financier on an ongoing and systematic basis visit jurisdictions to originate or structure new financings where the financier does not have a permanent presence.
Exchange controls
A financier providing financing in a foreign jurisdiction will need to ensure that the customer is able to repay the financing in the same currency that the financing was advanced to the customer and that no conversion in its equal currency in the customer’s jurisdiction is required. In addition, financiers in cross-border financings need to obtain protection against foreign exchange risks by including a ‘judgment clause’ in the underlying financing documentation.
This will enable the financier to obtain a judgment against the customer in a foreign jurisdiction which must be satisfied in the currency stated in the financing documents or its readily transferable equivalent in the required currency which exchange rate shall be determined at the time the financier receives actual payment.
Financier liability
During the origination and structuring phase and prior to the issuance of any commitment letter or mandate letter with respect to the provision of financing, the financier will need to understand whether under the laws of the customer’s jurisdiction the financier could be held legally accountable for a customer’s financial losses due to various actions taken by the financier.
For example, in some jurisdictions like the US and the UK, if the financier fails to renew a financing or line of credit without apparent cause, or if it improperly forecloses on a financing without adequate notice to the customer, the financier could be required to compensate the customer for any damages suffered as a result of the financier’s omissions or actions.
Cross-border legal opinions
The financing of a cross-border transaction will involve the laws of several jurisdictions. These include the laws of the customer’s jurisdiction of incorporation, the laws of the financiers’ jurisdictions of incorporation, the laws governing the financing documentation and the laws of the jurisdictions where collateral may be situated. In this respect, a financier will require legal opinions to be provided with respect to the laws of two critical jurisdictions, the laws of the customer’s jurisdiction of incorporation and the governing law of the financing documents.
The legal opinion will cover specific legal aspects involved in financing the transaction and will address the following issues:
(i) the validity and enforceability of the financing documentation;
(ii) the valid incorporation and existence of the customer;
(iii) the authority of the customer to enter into the financing transaction;
(iv) the applicability of stamp duties, taxes and exchange controls in relevant foreign jurisdictions;
(v) licensing and registration requirements and other approvals that must be obtained in connection with financing the transaction; and
(vi) where the financing is secured, the validity, enforceability and perfection of the security.
Governing law
The principle governing the enforceability of foreign judgments before the Malaysian courts is that of reciprocity. For example, since Singapore is listed in Malaysian Reciprocal Enforcement of Judgments Act 1958 (Act), the Singaporean judgment is enforceable before the Malaysian courts, or vice versa, by registering the Singaporean judgment in Malaysian courts and thereafter the same shall be enforced. If a country is not on the judgement reciprocity list, the Yang di-Pertuan Agong (Sultan) may, if he is satisfied that in the event of the benefits conferred by reciprocity, extend the judgment reciprocity rule to judgments given in the superior courts of any country or territory outside Malaysia.
Closing cross-border financings
Closing any financing requires the satisfaction of various conditions and significant co-ordination, the financier’s counsel prepares a comprehensive checklist specifying the responsibility of the various critical path items and all other conditions that must be completed in order to close the financing in a timely manner.
Conclusion
The above discussion only covers some of the issues which are pertinent for cross-border financing transactions. There might be other issues which are relevant depending on the nature of the financing and the proposed security interest thereof. It is advisable for the interested party to obtain proper advice from a local counsel practicing in the relevant jurisdiction to ensure that the proposed transaction is valid and enforceable under the relevant laws and regulations of that jurisdiction.
Farhah Hayati Mamat is a partner and Whalan Kazombiaze is an Islamic finance executive in the Global Financial Services & Islamic Banking Practice of Azmi & Associates. They can be contacted at
[email protected]
and
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respectively.