Despite rather stiff competition, Labuan IBFC has made considerable progress as an international business and financial center. In moving ahead, it is leveraging on, among others, Islamic finance, targeting players from within Asia Pacific and beyond, especially those who see this region as the next center of global economic growth.
This leads to the issue of whether Labuan IBFC can develop as a viable bridge linking the Islamic activities of the Gulf region and Asia to become a center where players from both markets can converge and collaborate even as they compete against each. This hypothesis may not be so farfetched as Asians are seeking Middle East petrodollars and those in the Middle East are drawn by the more secure havens in Asia for productive investments.
A roundtable discussion among Islamic finance participants active in Labuan IBFC as well as a scholar and a legal practitioner focused on how best this jurisdiction can cash in on its geographic location and first mover advantage to grow from being an intra-regional Islamic finance hub to an interregional port of call for all West Asian funds and investors looking for a home in East Asia.
How best can Labuan IBFC undertake its extra-regional mission? What are the issues and how can they be overcome, as Labuan is already progressing well in certain Islamic finance niche markets — asset management, cross border transactions, financing facilities?
Dr Aznan Hasan: In terms of location, Labuan is very well placed between the Gulf and Asia. Even though Hong Kong and others in the Far East are thinking of promoting Islamic finance, Labuan has the right location to play a very central role. Labuan should focus on leveraging Malaysia’s pole position in Islamic finance and look into ways of collaborating with the Malaysia International Islamic Finance Centre (MIFC). Besides promoting the basic areas of Islamic finance, it can also look into specific areas to leverage on since MIFC has pillars such as Sukuk origination, Islamic fund and wealth management, international Islamic banking, international Takaful business and human capital development. If Labuan works together with MIFC, this will bring about tremendous results in placing Labuan in the global Islamic finance arena.
Martin Crawford: I totally endorse that. There are over 70 international financial centers in the world, all competing vigorously against each other. Right now, there is a sort of sea change underway because of the crackdown on tax evasion or avoidance.
Our sustainable niche is Islamic finance. With conventional finance having issues, there is no better time to use Islamic finance as the platform for raising Labuan’s awareness. Nothing is fundamentally broken about Labuan that would prevent it from competing, making its way ahead of Hong Kong and Singapore. So really, it is merely an awareness issue.
How important is geographic location because you can now do business from anywhere in the world?
Mohamad Safri Shahul Hamid: Labuan had a head start, a first mover advantage, as the world’s first two Sukuk issues were issued by Labuan-based SPVs (special purpose vehicles) and listed on the LFX (Labuan International Financial Exchange) in 2001 and 2002. Labuan has a dedicated set of guidelines on Islamic finance and has promoted the setting up of Islamic banks via windows in conventional institutions. There are 36 Islamic financial institutions and related firms on the island. We also have the people, the players, in Labuan.
Unfortunately, having the players alone is not enough. The development of Islamic finance is centered in Malaysia but jurisdictions in Asia are now trying to embrace Islamic finance. They include Singapore, Indonesia, Brunei Thailand, Korea and Japan. Nevertheless, this in a way is good for Labuan because as the general level of awareness increases, Labuan should benefit.
Even though Malaysia has been the most prolific issuer of Islamic bonds, almost all were ringgit denominated and were not cross-border transactions, as much of the deep liquidity was onshore in Malaysia. But now we are seeing interest coming from other countries, and that should benefit Labuan as this interest lifts the Islamic financial services industry as a whole. The setting up of a marketing company, Labuan IBFC Inc Sdn Bhd, to step up the promotional and marketing activities is a good thing.
Dr Aimi Zulhazmi Abdul Rashid: As a trust company facing real issues in Labuan, we feel that although offshore and Islamic finance are different areas, we can converge them. Last August, the Cayman Islands allowed companies to register in the Arabic language and issue share certificates in Arabic. Another example is a Jersey-based trust company which opened an office in the Middle East to tap the Islamic finance market covering investment holding, property financing and family estate planning. Labuan should be aware of the competing jurisdictions clamoring for Islamic finance. If we are looking at the Middle East and making Labuan the crossroads for Asia and the Middle East, the authorities should consider doing what the Cayman Islands did.
Singapore has been very quick off the mark in pushing Islamic finance. Hong Kong is only slightly behind. To keep ahead, Labuan is, among other things, about to have omnibus legislation for Islamic finance. To what extent will this help in drawing transactions from the Gulf area and Asia? What can Labuan do to attract Gulf players to use Labuan as their launch pad into China, or even Indonesia since its system is still very basic?
Ahmad Lutfi Abdull Mutalip: In Islamic banking, the first thing Malaysia did was to create the Islamic Banking Act as opposed to other countries which use whatever laws they already have. People look at Malaysia for good laws and good governance. Malaysia, because of its racial mix, is a good launch pad for those from the Middle East to connect with the growing, emerging economies like India and China. When a business is launched in Labuan, we have Malaysian Chinese working to convince Chinese investors and fund managers, likewise for those from India.
So, this omnibus law for Islamic finance is the right step because we should shift to a single authority overseeing both the business and the financial side, like the Monetary Authority of Singapore (MAS). That could be an advantage for Labuan compared to Kuala Lumpur because Kuala Lumpur has two sets of regulators. But on the delivery system, it must be ensured that Labuan is a safe haven rather than a tax haven.
Aznan: Laws and guidelines are one thing, but what is more important is facilitating. Malaysia has been among the best regulators in Islamic finance, but we also need to enhance facilitating a business entity to come to Labuan to do business by leveraging on the benefits of Labuan and Malaysia. What the Cayman Islands did is something that Labuan should also do now.
Labuan may be lacking in awareness, and people may have a certain perception, one of which could be that Labuan is just a place to camouflage a business which is not real. Even the Shariah perspective of Labuan could be in question. We need to settle the awareness and perception issues as well as that of facilitating business if we want to sincerely promote Labuan.
Crawford: This is a challenge. I’ve been involved for a year now (with Labuan IBFC) and there have been improvements. The creation of a separate marketing front is a good thing because it means we can package an application in a way that the bureaucrats can sign off on it quite quickly. We need to beef up our capability on Islamic finance but, increasingly, I see Labuan not as a place or a geographic island but more as a concept in the legal perspective of Malaysia. Whether you do it in Kuala Lumpur or Labuan or elsewhere in the country, it is really irrelevant because at the global level, the player doesn’t care.
Hence, as part of Malaysia’s measures to liberalize the financial sector, offshore banking institutions in Labuan will be allowed to also have a physical presence onshore from 2010. Insurance companies can do so from 2011. Labuan holding companies can do so immediately.
This is a terrific step, and if we could do the same with Islamic structures, Islamic finance institutions licensed in Labuan could operate anywhere in Malaysia without having to be based in Labuan. That would be interesting as it would marry the best of what Malaysia as a financial center has to offer from both onshore and offshore.
Aznan: Having Labuan and the MIFC can be a good thing, but if this is not well managed, it could create confusion for the market. Players need to be clear about what they get when they come to either.
Aimi Zulhazmi: Players who want to issue Sukuk in US dollars but out of Kuala Lumpur will ask for the right authority. Is it SC (Securities Commission), MIFC or Labuan? There are also other grey areas. If the issuance is ringgit denominated, then it is the SC. But if it is US dollar denominated out of Labuan, to whom do you go? The word they use in the Caymans is nimbleness, about how nimble you are to adapt to the changing market environment. Labuan has very good infrastructure, and the new omnibus act for Islamic finance is a move in the right direction and is what the players have been asking. For the past five years, Labuan has been one of the best international financial centers for Islamic finance, banking and similar structures.
Now Labuan is to have a law to promote foundations, which are akin to trusts, as a new vehicle to cater for investors originating from countries practicing civil law. Foundations have evolved into an effective asset protection and wealth management vehicle. We are looking forward to that, especially as we specialize in Islamic wealth management. There is no single Islamic trust law yet in the world. So this could be the first one.
There will also be guidelines on Shariah compliant trusts in Labuan which make our products acceptable across various jurisdictions. This is a step forward, but as Dr Aznan said, legislation is one thing. Selling, marketing and positioning is another.
Crawford: If there is confusion between Labuan and the MIFC initiative we should clarify the boundaries or Labuan should give something up if it means more clarity in the market place. Regardless of whether it is Labuan or MIFC, the focus should be Malaysia.
Aznan: Listen to the market. The one thing people talk most about Malaysia is its many initiatives. This is good, but if you don’t prioritize and don’t synergize, people become confused. They ask us: “Should I go to Labuan IBFC or Malaysia onshore? Should I go international under MIFC?” We don’t tackle this issue well.
Mohamad Safri: The government needs to promote Labuan as a niche global center for Islamic finance, especially with the forthcoming omnibus law, the Labuan Islamic Financial Services and Securities Act (LIFSSA), that will help create a more efficient and coherent legal framework, mitigating any legal anomalies arising from the application of Islamic principles.
This has to be communicated to market participants such as international bankers, lawyers and tax advisors. People in Dubai, Bahrain and London are aware about the Cayman Islands, Jersey and Luxemburg but not of Labuan. They are aware of Singapore, which is nimble and more efficient. Sooner or later, it will catch up with Labuan. All this confusion between MIFC and Labuan is not helping Labuan at all.
Crawford: All onshore regulations, even the MIFC regulations, don’t do away with withholding taxes. Only Labuan structures are exempted from withholding tax as Labuan has a separate tax regime although both are under Malaysia’s Inland Revenue Board.
The confusion in the market place is very real and we fully understand the need to be clear about what goes where, the distinction and the similarities between what is available onshore Malaysia and offshore Malaysia.
Aznan: Whatever we want to do, do it fast. For Islamic finance, you must have the basic infrastructure and the Shariah component. Singapore and Hong Kong have the first one well organized. They lack the second. While Labuan is very good in the first category, it still lags behind the others. On the second component, Labuan is very strong, but if the first is not conducive enough, it won’t entice people to come and do business here. Singapore understands this well and is pushing on the second part. We really do need to have our cars in 5th gear!
Crawford: Going against Singapore and Hong Kong is like trying to prevent London from being a center. So strategically, rather than trying to beat them, how can we join them in some way? How best can we offer what we’ve already dealt with — the laws, taxes and infrastructure?
Mohamad Safri: Labuan can have a collaboration with London, which needs to beef up to become the Islamic finance center in Europe. Labuan can also ride on the SC’s collaboration with DIFX (Dubai International Financial Exchange) because Labuan and DIFC are, if I am not mistaken, the only offshore centers that have Islamic guidelines. For a link between Asia and the Middle East — the Silk Road — we need to have that collaboration.
Mohamad Safri: Singapore emerging as a center will be good for Labuan because you will get some business from Singapore. From the Shariah perspective Labuan is still the most sophisticated whereas Singapore has the infrastructure. Singapore and Hong Kong embracing Islamic finance will be good for Labuan because Labuan has the head start. We can’t stop Singapore from taking over some of Labuan’s business as the market continues to evolve; we have to keep trying to improve ourselves.
How about importing significant players from these areas? Why not get Singaporean players to operate outside of Singapore, in Labuan maybe? In this way Labuan could develop a broader, more international stable.
Aimi Zulhazmi: I agree. I’ve found that working on Islamic trust alone is not easy. When customers open accounts with us, we have difficulties bringing their assets into the Labuan custodian realm because the banks holding the assets will not easily transfer their portfolios to another bank. So Lofsa (Labuan Offshore Financial Services Authority) needs to attract private bankers to Labuan. UBS and Societe Generale have already made Singapore their hub in Asia. If Labuan is serious about high net worth Islamic wealth management, you have to bring them in.
Crawford: When you say bring them to Labuan, are you talking physically locating people there or become licensed to operate out of?
Aimi Zulhazmi: It cannot be as it is now, with Barclays servicing corporate clients but not high net worth individuals. We need international banks to open offices in Labuan doing more than just corporate work. It will be easier to transfer assets between banks if both banks are in Labuan. At present, if I want to transfer my assets in Luxemburg to Bank Islam Labuan, the bank in Luxembourg will only want to issue bank guarantees.
Mohamad Safri: But what will entice UBS, Credit Suisse and other private bankers to come to Labuan? They already have offices in Singapore, which is just a couple of hours from Labuan. How will it benefit them?
Aimi Zulhazmi: Singapore is not an offshore center and has a domestic tax of 18%. Labuan’s rate is 3%, or nil for investment holdings. Singapore is not as tax efficient as Labuan, so if you have investments or are protecting your inheritance, you put it in Labuan. There are components in the Labuan Trust Act that are available nowhere else.
Crawford: The success of Cayman is its proximity to the US. Similarly, Jersey with London, Luxembourg with Europe. Likewise, the success of Labuan could be its proximity to Singapore or Hong Kong. It doesn’t mean that you need to put the bankers in Labuan; instead Labuan should be a Singaporean bankers’ first choice as a jurisdiction to domicile their structures and products in.
The financial sector liberalization measures that the Malaysian government recently announced focuses more on onshore activities rather than offshore. How can Labuan make the best of these measures?
Crawford: The offshore legislative package is coming through by the end of the year and we expect that the new range of products Labuan IBFC will soon be able to offer will greatly enhance its competitiveness, so we eagerly await this package being passed in Parliament. Still, there are a few gifts in the recent announcement for the offshore sector, too, which we welcome. The challenge for Labuan is to be as competitive and facilitative as other international business and financial centers.
Mohamad Safri: The Gulf is now more aware of the emerging markets especially India and China. There is talk of GCC investors moving to China, and that would be good for Labuan. But Labuan needs to increase awareness, because not many people in Dubai are aware of Labuan. I know that Labuan has been doing a lot of marketing in the last few years, but there needs to be more promotional activities.
Labuan should also ride on the liberalization of the legal services sector, as Malaysia is offering up to five licenses to international law firms to conduct international Islamic finance work from the country. The likes of Clifford Chance and Allen & Overy know that there are a lot of opportunities in Asia and, in terms of legislation, Labuan is THE place. These lawyers could predominantly be in Singapore and Hong Kong but these countries, when it comes to Islamic finance, are not there yet. So Labuan should take advantage of this.
Aznan: This goes back to two main issues. One is enticing people to come. For this, the banking and financial infrastructure must be clear, with all the legal and tax areas covered. And it should include Shariah. The second part is facilitation. This can come in many forms, including ease in registering businesses and making it easier to achieve business transparency.
Mohamad Safri: The government now allows holding companies to have an office in Labuan but operate onshore, so they don’t need to be physically present in Labuan. Labuan can approach a company wanting to expand to Asia with a package under which it can be based in Kuala Lumpur and yet enjoy Labuan’s tax benefits — 3% tax rate, reduced annual fee, no stamp duty, no exchange control, no capital control, and so on.
Aimi Zulhazmi: What we need is a flagship product in Labuan so when the product is mentioned, there is an immediate link to Labuan. Even though Labuan is expanding its range of products, you must have a flagship product to entice people to Labuan.
Crawford: For the Middle Eastern investors, is it the corporates or individuals who are looking to expand to Asia?
Mohamad Safri: Initially it will be the corporates, but gradually the individuals as well. China, India, Vietnam and Indonesia are all areas of interest to the Middle Eastern investors.
Many Malaysian banks have done private equity work for Indonesian banks, and there is no reason why this cannot be extended to providing services to the Gulf. This being the case, I think Labuan has the potential of becoming THE Silk Road between the Middle East and Asia.
Crawford: We’ve started the process by extending the membership of our international advisory panel. We’ve just added someone from Dubai to be a sounding board for what’s happening in other places before we move on to setting up offices in Dubai and Abu Dhabi.
What can be done about the perception in the Middle East concerning the Malaysian way of interpreting the Shariah?
Aznan: There are two approaches. One is for Labuan to just be a platform, without insisting that Islamic finance products follow a certain set of rules. Similar products compatible with the standards set by different jurisdictions are available in a single marketplace.
For example, there can be two similar products, with one compatible for use in Malaysia and the other suitable for the Middle East. Therefore, Labuan is just a market allowing everybody to sell, but this approach may work only for those who have a lenient approach towards Shariah. In the long run it may harm Labuan.
Aznan: The second approach will not only help Labuan but also help in portraying Malaysia as a whole. For example, at a meeting in Kuwait to sell a product to establish a fund in Malaysia, after my presentation on the Shariah aspect of the product, a sheikh asked: “Is this Shariah compliant?” I said, “Yes”. The second question was, “Your compliance or our compliance?” So I replied, “Your compliance, following your standards.” The third question was, “How much do you want?”
It’s the second question that was vital. People like this sheikh can help our businesses a lot. Singapore is very good at that. When Singapore started pitching Islamic finance, what it said was, “Our Shariah finance is in convergence with the Middle Eastern practices.” Singapore is basically portraying itself as a global player, different from its neighbor Malaysia.
Mohamad Safri: The second approach is the better one. For Labuan, as most of the clients and investors for Islamic finance are global, and since we’re trying to attract cross-border trading, we need to make sure that we have one rule that covers all. We don’t want to be in a position where our rules and Shariah standards preclude any group of investors.
Ahmad Lutfi: While the perception is that Malaysian standards are more lenient than those of the Middle East, we are actually more stringent.
Crawford: In theory, if we accept the global standards, how would we implement this? Would it be by instructing our Shariah advisory council to adopt those standards?
Aznan: A clause stating: “This fund follows the AAOIFI standard” will resolve a lot of issues on perception. In the Middle East, what they may call international standards may not always exactly follow the AAOIFI standards. They may have variations, but are basically in line with the AAOIFI. As a basic guideline, the AAOIFI standards should be the main reference.
Mohamad Safri: Labuan is an international center, and being more stringent will basically benefit it in the long run.
Crawford: Perhaps we could use the AAOIFI standards as the benchmark but be flexible enough to accommodate other variations, which may be demanded by the Shariah council or scholars in particular jurisdictions. This approach would allow for a universal standard, for instance AAOIFI standards, with certain adaptations. This might be the best way to move forward.
Companies such as Kuwait’s Investment Dar are defaulting on Sukuk. Do you see any shortfall in the flow of funds from the Middle East? If so, how will this affect Labuan’s vision to become the bridge between the two regions?
Aznan: The credit crunch has affected everybody, but Islamic finance less so in a direct manner. Nevertheless, our portfolios will definitely shrink. Still, the credit crunch has helped portray emerging markets and Asia as an alternative place to park assets because the sophisticated markets have been badly hit. So, I believe this is the time to show investors what Labuan can offer.
Could we summarize by suggesting how best Labuan can make its mark in Islamic finance?
Aznan: I feel that Labuan has a lot of potential, and what it should look at are awareness, infrastructure, facilitation of business, managing perception, establishing a niche area to build on, how to leverage on the MIFC, identifying other financial sectors to be developed, how to collaborate in particular areas and determine areas that Labuan can prevail over others.
Aimi Zulhazmi: Nimbleness, segmentation and high net worth. We should be nimble enough and adaptable enough; we shouldn’t have to change the law all the time. We should identify the right segments of international business that we want to be part of.
Ahmad Lutfi: Enhance governance, delivery system, and Islamic principles such as Amanah which are universal in values.
Crawford: Labuan is one of the few offshore financial centers that have continued to grow when most offshore centers have declined in business or gone into negative growth. So we are actually doing better than the market in new registrations, company incorporations and new structures. Great market share too.