Financial Services Act/Islamic Financial Services Act (FSA/IFSA)

Commercial banks (conventional and Islamic) and investment banks are governed by the Financial Services Act/Islamic Financial Services Act (FSA/IFSA) under the purview and supervision of Bank Negara (BNM).

Development Finance Institutions (DFI) such as Bank Pembangunan, SME Bank, EXIM Bank, Agrobank, BSN are governed by the Development Financial Institutions Act. Under the Act, selected DFIs have been placed under the purview of BNM. Besides BNM, the DFIs are also supervised by the Ministry of Finance and their respective ministries , e.g. Agrobank under the Ministry of Agriculture and Agro-based Industries.

Capital market activities (related to financial instruments e.g. shares, ICULS, warrants that are offered to the public, bonds and sukuk) are governed by the Capital Markets and Services Act (CMSA). The regulatory body is the Securities Commission. If the instruments are listed, the issuing entities must also adhere to Bursa Malaysia’s guidelines.

There are also many other non-bank financial intermediaries in the financial system such as insurance and takaful companies, pension & provident funds (EPF, KWAP, LTAT, LTH), CGC, Cagamas, credit companies, factoring and leasing companies and money changers.

Ordinary shares, preference shares, loan stocks and bonds.

Ordinary shares, preference shares, loan stocks and bonds. These are common types of financial instruments. Sometimes, you see the word “convertible” and/or “redeemable” attached to the financial instrument (except for ordinary shares). Examples:

Redeemable convertible preference shares (RCPS) or
Redeemable convertible unsecured loan stocks (RCULS).

Redeemable means the financial instrument can be redeemed for cash. The company will pay the holder the nominal amount of the instrument.
Convertible means it can be converted into ordinary shares. The conversion ratio of how many ordinary shares will be received are set upfront.

So RCPS means the preference share can be redeemed for cash or can be converted into ordinary shares.

Sometimes, there is an additional “C” in the instrument name, e.g. RCCPS. It stands for cumulative. It means that any unpaid dividends this period will be carried forward and added to the next period’s dividends.
The “I” in ICULS stands for irredeemable.

A convertible bond means the bond can be converted into ordinary shares.

If the financial instrument is “Exchangeable”, it means it can be exchanged for another financial instrument.

OPM

What is “OPM”? And why is it so sought after?

OPM is “Other People’s Money”. It is a most desirable commodity because if you use OPM rather than your own cash for your business investments, your return on equity (ROE) will increase substantially. Imagine if you don’t put in any equity, your ROE which is profit divided by zero is infinity!

The smart entrepreneur will try to borrow as much as he can in whatever form. He will only give away the shares in his company as a last resort unless those shares are valued at a substantially higher price than his initial cost.

Income tax and consumption tax

The main sources of income to a Government are taxes. Here, we will look at income tax and consumption tax or GST as we are familiar with in Malaysia.

Income tax is normally progressive, meaning, the higher your income, the higher the tax rate. Hence, the rich will get taxed at a higher proportion of his income than the poor. This type of tax results in the rich subsidising the poor.

For GST, you pay tax on what you consume at the same rate for all taxpayers. One argument is that GST is fair because you are only taxed for what you use. However, everyone needs to buy necessities. The poor consumes a much higher proportion of his income than the rich. Hence, he will end up paying a high tax rate than the rich. The poor gets hit much harder than the rich in a GST tax system. GST is a regressive tax.

What is important ultimately is what the Government does with the tax revenue. Any imbalance arising from the tax system can be addressed by the Government through its socio-economic agenda and spending.

Leasing

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Leasing is a popular form of financing. There are 2 types of leases, operating and finance lease.

For clarification, the lessee is the user of the asset while the lessor is the financier of the asset.

In operating lease, the lessor owns the asset and is responsible for its maintenance and insurance. The contract may be cancelled and the asset goes back to the lessor. The lessee recognises the lease payments in its P&L. That’s all the effect on the company’s financial statements. Typical assets leased are photocopying machines, computers and automobiles (not to be confused with HP for cars).

In a finance lease, the lessee owns the asset and is responsible for its maintenance and insurance. This is akin to the company borrowing money from a bank to buy the asset. The asset appears in the lessee’s balance sheet and is depreciated. The lease payments are discounted at the lessee’s borrowing cost and appear as a liability in the lessee’s balance sheet. Assets leased include buildings and aircraft.

Hence, a company will choose finance lease if it wants to report a bigger balance sheet. If it doesn’t want to have a high gearing (debt), it will choose operating lease.

Collateral

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When you borrow money, a bank will very likely ask you, “What collateral (security) can you give?”

What is collateral? That’s an asset pledged by a borrower to protect the lender’s interest. If the borrower defaults ie. do not pay back the loan, the lender can sell the asset to recover the money lent. Types of assets used as collateral include landed property, securities (shares), receivables, fixed deposits and plant, and machinery.

For an individual who is applying for a housing loan, the house to be financed will be the collateral for the mortgage. If the individual defaults, the bank will sell the house. If there is a shortfall between the sales proceed and the loan outstanding, the lender will claim the shortfall from the borrower. This happens when the house value is below the loan value. This is called negative equity, which hit many homeowners in the USA during the subprime crisis.

Share investing – dividends

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An investor gets 2 forms of return from share investing – dividends and capital appreciation when the share price rises. We take a look at dividends here.

If you are a retiree, what kind of shares should you buy? As a retiree, you need a dependable passive source of income because you no longer have a salary. You also cannot take on high risks because unlike a young investor, you do not have a long horizon to recover any loss.

Shares with a steady dividend payout suit that investment profile. These are typically blue chip stocks which are market leaders in matured industries. Some companies like TM have stated their dividend policy of how much they will pay out as dividends from yearly profits. They can do that because they do not need to invest aggressively or unexpectedly. Young companies on the other hand need most of their cash to be reinvested.

Look also at the dividend yield of the company. This is dividend divided by the current share price. This ratio changes as the share price changes. A 5% dividend yield means the dividend paid is 5% of the current share price. So assuming the company’s situation does not vary in the future, you can expect a return of 5% from buying the share.

Shutting down or merging?

With PH in Government, there has been a flurry of news on shutting down or merging Government agencies.

This brings to mind the merger of Sime Darby, Guthrie and Golden Hope into Synergy Drive. The name was obviously chosen to tie in with Sime Darby’s initials, signalling the dominant entity in the merger. The merger failed. Demerger followed. But that merger exercise was perhaps not done with the right objectives from the beginning. There were no clear benefits to be gained from the merger.

So how do the Government entities now prepare for a merger? Unlike commercial entities, the objective of their merger is towards meeting the Government’s objectives which are likely to have socio-economic factors or cost efficiency purposes.

How to align the objectives of the merged entity, the identity, the funding structure, the organisation structure? Constitution of the board? Retrenchment? It will be a survival of the fittest. Knowledge is king as everyone manoeuvres and jostles to be on top.

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The yield curve is flattening!

The yield curve is flattening! Inverting soon. Recession coming!

The yield curve is one of the most trusted leading indicators of an economic slowdown. Lately, much has been made of the US yield curve flattening. The yield curve is a plotting of Government bonds (or treasury bills)’s interest rates of various maturies. A normal yield curve is upward sloping. Investors need higher premium to compensate for longer term uncertainties and because of the expectation that the economy will expand in the future. The reverse is hence true when the longer term rates are lower than the shorter term ones (i.e. expectation of recession), causing the yield curve to invert.

There are analysts considering pressing the panic button while there are others who are saying Hold your horses. The Malaysian yield curve is still upward sloping. But the far reaching US economy has an impact on the world economy, including Malaysia’s.

As the new Malaysian Government works to rein in the national debt, it has no choice but to scale back or cancel big ticket projects. Overall consumption will decrease. Hence some form of contraction to the economy is inevitable. How much is the question now.

The Turkish lira crashed

The Turkish lira crashed, falling by almost 50% against the USD over the last 12 months. Good news for Malaysians going for holiday in Turkey. Bad news for Malaysian companies like MAHB and IHH which have big investments in Turkey.

All eyes are watching what Turkey’s President and the Central Bank do next. The Turkish problem has similarities with the Malaysian 1997 recession and currency crisis. The Malaysian economy had just come off a period of high growth. Like Turkish companies too, many Malaysian companies had borrowed in foreign currencies though revenue was in Ringgit. These Malaysian companies had wanted to take advantage of the low interest rate from borrowing overseas e.g. issuing Samurai bonds. Instead, they got hit big time by the Ringgit’s depreciation.

Malaysia resisted going to the IMF for help, slapped on capital controls. Malaysia managed to get out of the recession and currency meltdown in one piece (though the Ringgit never managed to recover back to the pre-recession levels). What will Turkey choose to do next?

NB: If you are interested to be a trainer on ad hoc basis, please contact firdaus at firdaus@symphonydigest.com