Malaysian Government Securities
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INTRODUCTION
Definition of Malaysian Government Securities
Malaysian Government securities are marketable debt instruments issued by the Government of Malaysia to raise funds from the domestic capital market to finance the Government's development expenditure and working capital. The central bank, Bank Negara Malaysia in its role as banker and adviser to the Government, advises on the details of Government securities issuance and facilitates such issuance through various market infrastructures that it owns and operates.
Currently, the various forms of Government securities in Malaysia are:-
� Malaysian Government Securities (MGS)
Interest-bearing long-term bonds issued by the Government of Malaysia to raise funds from the domestic capital market for development expenditure.
� Malaysian Treasury Bills (MTB)
Short-term securities issued by the Government of Malaysia for working capital.
� Government Investment Issues (GII) and Malaysian Islamic Treasury Bills (MITB)
Long-term and short-term non-interest-bearing Government securities, respectively, issued based on Islamic principles by the Government of Malaysia.
Objective of issuance
MGS were initially issued to meet the investment needs of the Employees Provident Fund (EPF), local banks and insurance companies. In the late 1970s and early 1980s, MGS were issued to finance the public sector's development expenditure. In contrast, by the 1990s, the purpose of MGS issuance was extended to funding part of the Government's budget deficit and prepayment of some of the Government's external loans. The Government continued to issue MGS during the fiscal surplus of 1993-1997 to meet the market demand for MGS. GII and MITB, on the other hand, were issued to allow Islamic banks to hold liquid papers that meet their statutory liquidity requirements. The issuance of these papers also enabled them to invest their liquid funds in instruments that are issued based on Shariah principles as they are unable to purchase or trade in Malaysian Government Securities (MGS), Malaysian Treasury Bills (MTB) or other interest-bearing instruments.
Relevant Legislations
Malaysian Government securities are issued under several different laws. Conventional debt instruments such as the MGS and MTB are issued under the Treasury Bills (Local) Act 1946 (Revised - 1977) and Loan (Local) Act 1959 (Revised - 2004) respectively. On the other hand, Islamic securities such as the GII and MITB, are issued under the Government Funding Act 1983 (previously known as Government Investment Act 1983). The Loan (Local) Act 1959 authorises Bank Negara Malaysia to raise funds within Malaysia on behalf of the Minister for the Development Fund, while the Treasury Bills (Local) Act 1946 provides the power to the Minister of Finance to borrow money through the issuance of Treasury Bills. The Government Funding Act 1983 provides for the raising of funds by the Government of Malaysia using instruments that adhere to Shariah principles as approved by the National Shariah Advisory Council1. The Act grants the Minister the authority to receive investment by creating and issuing instruments evidencing such investment, on behalf of the Government of Malaysia. Under each separate Act, different issuance limit for both conventional and Islamic instruments are set, from time to time, by the order of the Yang di-Pertuan Agong, the constitutional monarch of Malaysia, as published in the Gazette. The order must, as soon as possible after its publication, be laid by the Minister before the Dewan Rakyat.
Information for Non-Resident Investors
Foreign exchange administration policies
Malaysia maintains a liberal foreign exchange regime. The foreign exchange administration supports the monitoring of funds in and out of the country to promote financial and economic stability. As part of the continuous efforts to enhance efficiency and reduce cost of doing business, the foreign administration rules have been gradually eased and liberalised.
Non-residents are free to make any portfolio investments including debt securities such as Government securities as well as participate in Government securities auctions by submitting applications through any Principal Dealers appointed by Bank Negara Malaysia. There are no restrictions on the repatriation of capital, profits and income earned from Malaysia, including salaries, wages, royalties, commissions, fees, rental, interest, profits or dividends. To complement the non-residents investment strategy, non-residents may obtain financing from licensed onshore banks both in ringgit and foreign currencies and enter into foreign exchange contracts on spot or forward basis with licensed onshore banks to actively manage currency risks arising from investments in ringgit assets. Non-residents are also free to convert foreign currency into ringgit and vice versa.
Non-residents may open and maintain any number of External Accounts with any onshore financial institutions. The ringgit funds in an External Account may be used for payments to residents for purchase of ringgit assets or services provided in Malaysia or be converted into foreign currency with licensed onshore banks and repatriated at any time. There are also no restrictions for a non-resident to open and maintain any number of foreign currency accounts with licensed onshore banks and licensed merchant banks in Malaysia. Non-residents can freely participate in the trading of financial futures on the Malaysian Derivative Exchange (MDEX), including futures contracts on the Kuala Lumpur Interbank Offer Rate (KLIBOR) and Malaysian Government Securities. Non-residents may also freely invest in exchange-traded funds (ETF) on the Malaysian stock exchange that invests in portfolios of government and quasi-government securities.
Non-residents are exempted from withholding tax in respect of interest income earned form investments in ringgit-denominated bonds (other than convertible loan stock) approved by the Securities Commission.
There is no capital gain tax being imposed on investment in Malaysia.
There is no stamp duty charged on transfer or trading of Malaysian Government debt securities or private debt securities approved by the Securities Commission.
TYPES OF GOVERNMENT SECURITIES
Malaysian Treasury Bills (MTB)
MTB are short-term securities issued by the Government of Malaysia to raise short-term funds for Government's working capital. Bills are sold at discount through competitive auction, facilitated by Bank Negara Malaysia, with original maturities of 3-month, 6-month, and 1-year. The redemption will be made at par.
MTB are issued on weekly basis and the auction will be held one day before the issue date. The successful bidders will be determined according to the most competitive yield offered. Normal auction day is Thursday and the result of successful bidders will be announced one day after. MTB are tradable on yield basis (discounted rate) based on bands of remaining tenure (e.g., Band 4= 68 to 91 days to maturity). The standard trading amount is RM5 million, and it is actively traded in the secondary market.
Malaysian Islamic Treasury Bills (MITB)
MITB are short-term securities issued by the Government of Malaysia based on Islamic principles. MITB are usually issued on a weekly basis with original maturities of 1-year. Normal auction day is Thursday and the results of successful bidders will be announced one day after, on Friday. Both conventional and Islamic institutions can buy and trade on MITB.
The MITB are structured based on Bai' Al-Inah principle, part of sell and buy back concept. Bank Negara Malaysia on behalf of the Government will sell the identified Government's assets on competitive tender basis, to form the underlying transaction of the deal. Allotment is based on highest price tendered (or lowest yield). Price is determined after profit element is imputed (discounting factor). The successful bidders will then pay cash to the Government. The bidders will subsequently sell back the assets to the Government at par based on credit term. The Government will issue MITB to bidders to represent the debt created. MITB are tradable on yield basis (discounted rate) based on bands of remaining tenure (e.g., Band 4= 68 to 91 days to maturity). The standard trading amount is RM5 million, and it is actively traded based on Bai ad-Dayn (debt trading) principle in the secondary market.
Malaysian Government Securities (MGS)
MGS are long-term bonds issued by the Government of Malaysia for financing developmental expenditure. MGS are fixed-rate coupon bearing bonds with bullet repayment of principal upon maturity while coupon payments are made semi-annually. The securities are issued via competitive auction by Bank Negara Malaysia on behalf of the Government. The successful bidders are determined according to the lowest yields offered and the coupon rate is fixed at the weighted average yield of successful bids.
An annual auction calendar which outlined the timing, tenure and issuance method (new issue/ re-opening) are pre-announced in the year-end for the subsequent year issuances to enhance market transparency and certainty. The actual issuance size is announced a week before the issuance date. The typical issuance size ranges from RM1 billion to RM3.5 billion depending on Government financing requirement.
The Government is committed to continuously issue 3-year, 5-year and 10-year MGS as benchmark securities as part of its efforts to develop the benchmark yield curve. The benchmark securities were often reopened to enlarge outstanding issue sizes in order to promote market liquidity. In addition, 15-year and 20-year MGS were also issued to lengthen the benchmark yield curve.
Secondary market for benchmark securities is liquid with average daily transaction volume varying from RM100 million to RM500 million. Standard transaction is RM5 million per lot. Trades are settled in two business days (T+2) and are quoted on a price basis to two decimal points. Neither stamp duty nor commissions are paid on the transfer of the securities. For transactions via money brokers, brokerage fee is payable.
Government Investment Issue (GII)
GII is long-term non-interest-bearing Government securities based on Islamic principles issued by the Government of Malaysia for funding developmental expenditure. Similar with MGS, GII is issued through competitive auction by Bank Negara Malaysia on behalf of the Government. The GII issuance programme is pre-announced in the auction calendar with issuance size ranging from RM1 billion to RM3.5 billion and original maturities of 3-year, 7- year, 5-year and 10-year.
GII is based on Bai' Al-Inah principles, part of the sell and buy back concept in Islamic finance. Under this principle, the Government will sell specified nominal value of its assets and subsequently will buy back the assets at its nominal value plus profit through a tender process. Profit rate is based on the weighted average yield of the successful bids of the auction. The nominal value of buying back the assets will be settled at a specified future date or maturity, while the profit rate will be distributed half yearly. The obligation of the Government to settle the purchase price is securitised in the form of GII and is issued to the investors. At maturity, the Government will redeem the GII and pay the nominal value of the securities to the GII holders. GII is one of the financial instruments that are actively traded in the Islamic Interbank Money Market.
Comparison between Conventional and Islamic Government Securities
The conventional securities and the Islamic securities differ only in its structure in terms of complying with Islamic principles in its issuance. Islamic Government securities are similar to conventional Government securities in terms of their effective cash flows, issuance structure, legal status in being a direct obligation of the Government, its holdings and nature of transaction as financial products.
PRIMARY MARKET
Method of Issuance
The two methods of issuance adopted in the primary market of Government securities in Malaysia are market auction and private placement. Malaysian Treasury Bills and Malaysian Islamic Treasury Bills are issued weekly whereas 3, 5, 10, 15 and 20-year bonds which include Malaysian Government Securities (MGS) and Government Investment Issues (GII) are issued according to the issuance calendar.
The Government Securities Auction Calendar is published annually to promote transparency and enable financial institutions to plan ahead and invest more efficiently their investment and trading book. The auction calendar is usually released in December prior to the issuance year and contains the following information: i) Types of Government securities (MGS or GII) ii) Whether the issue is new or reopening iii)Method of issuance (private placement or market auction) iv) Month of issuance
All short-term and long-term Government papers, either conventional or Islamic, are typically auctioned through a variable-rate multiple-price auction format (also known as English auction). Market auctions are open to all Principal Dealers (PDs) listed in Annex G. Occasionally and periodically, a private placement is also conducted. Private placements are bilateral placements of specific MGS issues to an identified institution at the request or approval from the Ministry of Finance (MoF).
Auction Procedure
The tender announcement detailing the size and exact date of the issue would be announced to the market at least 5 business days before the issue date via the Fully Automated System for Issuing/Tendering (FAST) and major newspapers. The information would also be fed to other information providers such as Bloomberg and Reuters.
The "when-issued" (WI) trading would commence on the tender announcement date after stock creation in FAST. For more information on WI trading, please refer to the chapter on "Secondary Market".
The auction process of the MGS and GII is exclusively open to PDs. In the case of GII, all Islamic banks are also allowed to participate in the auction. PDs are obliged to tender competitively for a minimum of 10% of the issue amount. Bids submitted during the auction could be based on either price or yield. The price convention is used in reopening of existing securities and for trading in the secondary market. Meanwhile, bids would be submitted in yield if it is a new issuance. In this case, the weighted average of yields accepted will be the coupon for that particular new MGS or GII issue.
All bids are submitted by PDs via FAST. Non-PDs or other interbank institutions could also submit their bids via a PD with a maximum allotment limit of 30% per bidder. If bids are successful, RENTAS will allot the securities to the bidder by lodging the securities with their appointed Authorised Depository Institutions (ADIs). Settlement would then take place automatically in RENTAS on a Delivery-versus-Payment (DvP) basis. The Central Bank has the option to participate in MGS auctions with the purpose of obtaining securities for its market operations, whether for repurchase agreements or securities borrowing and lending. Bidding is conducted in a non-competitive manner, with the Central Bank being allotted at the weighted-average yield (price for re-opened securities) of the successful bids of other market participants to ensure fairness and market transparency. The maximum allotment limit for the Central Bank is currently capped at 10% of the total issue amount.
MGS Switch Auction
MGS switch auction involves the Government buying back or redeeming certain predetermined MGS (i.e. repurchase bond) that tend to be illiquid, and to replace them with more liquid benchmark MGS (i.e. replacement bond). The main objective of the switch auction is to enable the Government to consistently issue new MGS in all market conditions, including periods of fiscal balances or surpluses. It also provides more flexibility to the Government to manage its liability through the re-profiling of debt. At the same time, switch auctions could also be used to cater investors' demand for securities of certain duration.
Participation in a switch auction is voluntary. A switch auction will be announced in advance, at least one week prior to the actual issuance date. Replacement bonds only consist of existing re-opened stocks, as new issues are unlikely to be issued via this mechanism. The list of 'off-the-run' securities that market participants may offer as repurchase bonds as well as the yields of the replacement bond will be announced to the market prior to tender closing. Interested bidders are then required to submit their respective offer amounts of the repurchase bonds as well as their respective yield valuations via FAST.
Submitted offers would be compared against the Central Bank's internally constructed fair-valuation yield curve, which then determines the level and amount of offered bonds that are successful. The switch auction follows a variable-rate multiple-price relative-value auction format. The switch auction could either be conducted using the duration-neutral, cash proceeds neutral or matched nominal amount method. Currently, the amount of replacement MGS issued and allocated to successful offers would be rounded to the nearest RM5 million which is the standard lot for MGS trading. Due to the rounding process, any remaining difference between the total proceeds of the repurchase securities and replacement securities in the switch will need to be paid either by the bidders or the Government.
Primary Investors
Government securities auctions are open to all investors, but all bidders are to submit bids through PDs. Among the primary investors of Government securities are the Employees Provident Fund (EPF), Petroliam Nasional Berhad (Petronas - largest petroleum company in Malaysia), financial institutions (including PDs), insurance companies including Takaful operators (Islamic insurers), asset management companies and corporates.
SECONDARY MARKET
Secondary Market Trading
Government securities and other scripless debt instruments are traded in the secondary or "over-the-counter" (OTC) market either via a money broker, direct dealing on telephones or via the Electronic Broking System (EBS). In the secondary market, MGS benchmarks, the 3, 5 and 10-year are the most actively traded and commonly referred to as "on-the-run" issues. While non MGS benchmarks are referred to as "off-the-run" issues. Principal Dealers (PDs) appointed by Bank Negara Malaysia are committed to provide continuous two-way prices in MGS, as they are obliged to make market. Every morning PDs will submit and advertise their indicative bids and offers on all benchmark securities in the BIDS system. Non-PD financial institutions may also choose to make market by quoting two-way prices in the BIDS system. All trading done via the OTC market must be captured on BIDS system where the sellers of securities will key in the deal and buyers will confirm within a stipulated 10 minutes cut-off time from trade execution. Normal business hours for a regular government securities trade is for standard settlement or value spot i.e. 2 business days (T+2) settlement, from 9.00 a.m. to 4.30 p.m. from Monday to Friday excluding holidays. Government securities can also be traded on value today, value tomorrow or value forward.
All Government securities trades are settled based on a delivery versus payment (DvP) basis although free-of-payment settlement (FoP) is available where necessary. Reopened MGS shares the same stock identifiers with the existing stocks, therefore are indistinguishable and fungible. As Government securities are scripless securities, ownership and transfer of Government securities are reflected as book entries in the Authorised Depository Institutions (ADIs) custody accounts with Bank Negara Malaysia in the Real Time Electronic Transfer of Funds and Securities (RENTAS) system. Non-RENTAS members such as institutional investors and other financial institutions can transact scripless securities via their ADI. Cash payments of coupons and redemption proceeds will be passed to the investors via their respective ADIs.
"When-Issued" Trading
In the Malaysian market, 'when-issued' trading or WI commences upon formal announcement of a Government securities primary issue. WI is traded on the yield basis regardless of new or reopened issue, up to 3 decimal places. WI trading continues until the tender results are announced to the market. The value date for settlement of WI trades must be on or after the Government securities issue date but the standard value date is 2 business days (value spot). Trading on a WI is aimed at facilitating the price discovery process.
Repurchase Agreement (Repo)
A repo is a transaction wherein securities are sold at a particular price by one party (repo seller) to the other (repo buyer) with a commitment on the repo seller's part to repurchase the equivalent securities from the repo buyer (and a corresponding commitment on the repo buyer's part to sell the equivalent securities back to the repo seller) on a certain date and at a certain price, both such date and price being fixed as part of the same transaction. Repo in government securities are fully-assigned, with collateral securities identified at the initiation of the trade. Repo proceeds include accrued interests. Typically repos are conducted as 'classic repos' with both initial and variation margin applied on market values of collateral securities. Variation margin may be called when the fall in value of collateral securities exceeds a mutually agreed margin threshold. Collateral securities may also be replaced or substituted at any time upon mutual agreement, however this is rarely done in the market.
Coupon income received during the term of the repo may be returned by the repo buyer to the repo seller via 'manufactured dividend' or paid in cash on the date of coupon payment by the repo buyer to the repo seller. A popular treatment however is to conduct 'coupon reinvestment' whereupon the repo buyer retains the coupon payment and treats it like a partial early repayment of repo proceeds by the repo seller. Repo may either be "cash-driven" or "securities-driven". In a cash-driven repo, the repo transaction is used to obtain cash funding. Securities used as collateral are not specific and usually consists of off-the-runs. For securities-driven repo, repo buyers are specifically seeking a particular identified security typically on-the-runs or benchmark securities mainly for the purpose of covering short-sale positions. Both types of repo transactions are transacted between market participants and the central bank via standard repo and benchmark repo auctions respectively.
A standard repo auction is basically cash-driven and conducted daily for the purpose of liquidity management. The underlying collateral (commonly known as general collateral), mostly off-the-run issues are specified in each auction. The lowest bidder in terms of repo rates will be allotted first until the auction amount is fully allotted. Shortest maturity and highest credit quality collateral are allocated first to lower repo rate bidders before longerterm and lower-credit ones.
Repo auctions are conducted by Bank Negara Malaysia to complement clean money market borrowing, as repo rates are generally traded lower by 2 to 3 basis points compared to an unsecured or 'clean' borrowing over the comparable maturity term. On occasion, Bank Negara Malaysia will also provide liquidity under its standing facility using standard repos, typically bilaterally with market participants that experience liquidity shortages at the end of the day.
Benchmark or 'specials' repos are securities-driven transaction offered by the central bank to effectively lend specific securities, which in turn are either used to cover short selling activities or potential settlement failures by day-end. Bank Negara Malaysia conducts benchmark repo auctions twice a week on Tuesdays and Thursdays at T+2 settlements. Securities-driven repo auctions are conducted separately for each security on offer. Interested market participants may also approach Bank Negara Malaysia directly via 'reverse enquiries' to request specific securities via bilateral repos, subject to availability. Due to the scarcity and high demand of MGS benchmarks, securities-driven repo rates are transacted below normal repo rates, typically at least 10 basis points spread below the equivalent average unsecured interbank money market rates. Illustrative Example of a MGS repo transaction
Bank A entered into a 1-month (30 days) MGS repo agreement with Bank B on 5 July 2006 at a repo rate of 3.70% for a nominal amount of RM100 million of the 6.844% coupon MGS maturing on 1 October 2009. The details of the transaction are as follows, assuming no margin or haircut:
Trade Date : 3 July 2006
Value Date : 5 July 2006 (T+2)
Term of Repo : 1 month or 30 days
Maturity Date : 4 August 2006
Amount : RM100 million (nominal)
Security : 6.844% MGS maturing 1 October 2009
Clean Price : 106.96
Repo Rate : 3.70%
Last Coupon Payment Date : 1 April 2006
Next Coupon Payment Date : 1 October 2006
Days between Coupons : 183 days
Days Interest Accrued : 95 days
Calculations
Principal = 100,000,000 x (106.96/100) = RM106,960,000
Accrued interest = [(6.844/200) x (95 /183)] x 100,000,000 = RM1,776,448.09
1st leg Proceeds = RM108,736,448.09
Repo interest payable = 108,736,448.09 x 3.70% x 30/365 = RM 330,677.97
Final consideration = 108,736,448.09+330,677.97 = RM109,067,126.06
Settlement
On 5 July 2006, Bank A passed to Bank B RM100 million in nominal value of the underlying MGS (1st leg proceed of RM108,736,448.09). On maturity of the transaction (4 August 2006), Bank A repurchased the MGS from Bank B at a 2nd leg proceed of RM109,067,126.06, which includes the repo interest.
Institutional Securities Custodian Program (ISCAP)
Institutional Securities Custodian Program (ISCAP) was first initiated in early October 2004 and was officially launched in January 2005 to enhance secondary bond trading especially on the off-the-run issues. It supports Bank Negara Malaysia's strategic goal of improving bond market liquidity by releasing captive holdings of bonds which are usually held to maturity by institutional investors and financial institutions. ISCAP will allow institutional investors and FIs who choose to participate in this program to lend a pre-defined set of scripless securities (uncollateralised lending) to Bank Negara Malaysia in exchange for a lending fee. Bank Negara Malaysia will then borrow these securities and use it as part of the repo operations to manage liquidity in the interbank market.
ISCAP’s Objectives
i) Enable participating institutional investors and financial institutions to enhance total returns from these specified scripless securities currently held for long term through the receipt of lending fee from Bank Negara Malaysia;
ii) Increase local market activity of repo transactions with the release of selected scripless securities currently held-to-maturity by institutional investors/FIs;
iii)Increase the number and range of instruments available to Bank Negara Malaysia for the conduct of market liquidity management, thus allowing the Bank flexibility to use the most effective and appropriate instrument for monetary policy implementation.
Sell and Buy Back Agreement
Sell and Buy Back Agreement (SBBA) is an Islamic money market transaction entered by two parties in which an SBBA seller (seller) sells Islamic assets to an SBBA buyer (Buyer) at an agreed price, and subsequently, both parties entered into a separate agreement in which the buyer promises to sell back the said asset to the seller at an agreed price.
Securities Borrowing and Lending (SBL)
An SBL transaction involves an exchange of securities between two parties (lender and borrower) for a pre-determined period of time to meet temporary needs of either or both parties, typically dealers who need securities to support their trading activities. Securities borrowers are generally required to provide collateral to ensure performance of redelivery obligation. Other elements of SBL include; a) The lender earns a fee as consideration for the loan of the securities; b) Ownership transfer of the securities which are: c) From borrower to lender with regards to the collateral; d) From lender to borrower with regards to the securities lent; e) Both parties are entitled to the value of the coupon payments on the collateral or securities lent for the duration of the SBL transaction; f) The lender or borrower may recall the collateral or securities lent at any time during the duration of the SBL transaction after serving adequate notice, subject to payment of an early termination fee; g) At the end of the duration of the SBL transaction loan period, the borrower returns the securities lent to the lender, the lender will return the collateral to the borrower. All authorised Interbank Institutions are to sign the SBL Master Agreement prior to entering an SBL transaction. Principal Dealers are the only institutions authorised to participate as "lender" and "borrower" of securities. Other approved dealers and non-licensed institutions may only participate as "lender" while non-residents are not allowed to conduct SBL.
Regulated Short Selling (RSS)
Regulated short selling of Malaysian Government Securities (MGS) was initially allowed for Principal Dealers (PD) as to facilitate a more efficient execution of their market making responsibilities. Since November 2005, RSS has been extended to other interbank participants and universal brokers to increase domestic bond market liquidity, accelerate price corrections in overvalued securities, facilitate hedging of interest rate risk and promote activity in the repo as well as the securities borrowing and lending (SBL) market. All Authorised Interbank Institutions (AII) which includes commercial banks, finance companies, merchant banks and discount houses licensed under Banking and Financial Institution Act 1989 and universal brokers as approved by the Securities Commission can undertake short selling transactions. All short selling transactions must be a seller's own proprietary position, and not for third-parties.Eligible securities allowed in a RSS transaction are specific issues of MGS with an outstanding nominal amount of at least RM2.0 billion and remaining tenure to maturity of 10.5 years or less, at the time when the short selling position is created. Each participant's short position should also not exceed 10% of the outstanding nominal amount of each eligible security issue.
Only covered short selling is allowed whereby the short sold securities must be covered via repo or securities borrowing. With the exception of intraday transactions, naked short selling of eligible securities is not yet allowed in order to minimise market volatility and excessive speculative activities. All short sales of MGS are reported in BIDS and distinguished from normal sales via a Short Sale indicator checkbox. Principal Dealers also regularly disclose outstanding short sale positions by maturity buckets to Bank Negara Malaysia on a weekly basis.
With the inception of ISCAP, market participant now can borrow securities via repo or SBL transaction with Bank Negara Malaysia to cover their short position and manage settlement risks effectively. In order to ensure reasonable access to repo and SBL as short-covering mechanisms, participants must execute the Global Master Repurchase Agreement (GMRA) or the Securities Borrowing and Lending agreement with at least two other market participants (excluding Bank Negara Malaysia).
Investment in Government Securities by Retail Investors
MGS are available to retail investors with a minimum nominal denomination of RM1,000 and in multiples of RM1,000. Retail investors can purchase MGS in the secondary market via a PD or other financial institutions who are ADIs. As government securities are scripless securities, transactions are reflected as accounting book entries. Retail investors need to maintain a current or savings account with the ADI for cash settlement of their transactions as well as for crediting semi-annual coupon payments and principal repayment upon maturity of the securities. Currently, direct investment in Malaysian government securities by retail investors are not widely practiced and typically done by high-net-worth individuals.
Investment through Exchange Traded Funds
Indirect investment into Government securities may also be conducted by [[exchange-traded funds]] (ETF) on Bursa Malaysia, the national stock exchange. Currently only one ETF is listed and traded on the exchange, the ABF Malaysia Bond Index Fund or ABF Malaysia in short. The ABF Malaysia ETF is in turn invested into a portfolio of mostly government securities and certain quasi-government debt securities. The ETF may be bought and sold by both residents and non-residents alike on Bursa Malaysia through a licensed remisier or stockbroker for as little as 100 units of denomination. A separate trading account with a stockbroking firm and a custody account on Bursa Malaysia's Central Depository System (CDS) must be set-up for this purpose. The ABF Malaysia Fund pays regular income distributions drawn from coupon income of the underlying portfolio.
PAYMENT AND SETTLEMENT
Market Infrastructure
The issuing and auctioning of scripless government and corporate debt securities are automated through the Fully Automated System for Issuing/ Tendering (FAST) operated by Bank Negara Malaysia. Investors can purchase debt securities at the primary market by submitting bids to Principal Dealers who are all members of the FAST system. In addition, FAST also enable repurchase transactions between the Bank and interbank institutions. In 2005, FAST was upgraded to web-based application, thus provide greater information dissemination and transparency on primary market activities.
Meanwhile, the settlement of the primary and secondary market transactions in government securities and unlisted corporate debt securities take place through the Scripless Securities Trading System (SSTS), which is part of the Real Time Electronic Transfer of Funds and Securities (RENTAS) system. RENTAS, which was established in 1999 by Bank Negara Malaysia, comprised the Interbank Funds Transfer System (IFTS), which deals with large value funds transfers, and the SSTS, which allows the book-entry settlement and recordkeeping of holdings of scripless debt securities. A sale/purchase of securities from one party to another involves a book entry and intra-day settlement of funds in the cash settlement account maintained with Bank Negara Malaysia. The RENTAS system, which has straightthrough- processing capability would process, transfer and settle interbank funds and scripless transactions simultaneously in real-time. The RENTAS system is a delivery versus payment (DvP) Model 1 system, i.e. securities and funds settle gross throughout the day. For custody, the securities issued are in the form of Master Certificates and lodged by the issuer (i.e. the Government and corporate issuer) directly with Bank Negara Malaysia as the Authorised Depository for custody. Bank Negara Malaysia will hold the Master Certificate on behalf of all the holders and their scripless securities account for the purpose of trading and transfers. For non-RENTAS members, the function of recording the holdings and transactions is undertaken by the Authorised Depository Institutions (ADIs), which maintain aggregate cash and securities holdings accounts with Bank Negara Malaysia. The ADIs maintain separate account for each of the holder who is their customer.
The Bond Information and Dissemination System (BIDS) was established in 1997 to enhance transparency of secondary market information. BIDS is a computerised and centralised database on ringgit debt securities, providing information on the terms of issues, prices of trades, details of trades done including transactions on repo activities and relevant news on the various debt securities issued by both the Government and the corporate sector. Financial institutions have the obligation to report into BIDS details of trade done within 10 minutes of execution while the rating agencies, on the other hand, are required to update the issuer's ratings. Selected information from BIDS is shared on a near real-time basis with major newswire services like Reuters and Bloomberg. Information from BIDS is also transmitted to the Islamic Money Market website for wider information dissemination.
Market Convention
Long-term government securities are traded on Clean price basis, but settled on a dirty price basis that includes accrued interests or dividends. Treasury bills are traded on discount yield basis and quoted in the form of maturity bands of Bands 1 to 10 depending on number of days to maturity. Treasury bills that fall under the same maturity band are equally acceptable for delivery for any band-based quotations. Prices and discount yields are quoted typically up to two decimal places for all transactions. Standard settlement is T+2, although trades can also be settled for same-day, next-day or forward settlement of typically not more than T+5. The standard market lot per transactions between market participants is RM5 million. Odd-lot amounts of less than RM5 million are also traded but not as frequently and at potentially wider bid-offer spreads under normal market conditions.
Coupon payments on individual government securities are usually made semi-annually and the day count is actual/ actual. At present, there are no standard coupon payment dates. Coupon payments are made at semi-annual date intervals determined backwards from the maturity date of the security. MGS and GII are typically issued in exact full number of years with the maturity dates being exact date of year anniversaries of the issue date, there are naturally no odd-first or odd-last coupon periods with only a few exceptions. A business day is defined as any working day from Monday to Friday in the Federal Territory of Kuala Lumpur excluding any day which is a public holiday or bank holiday.
The trading conventions are as follows:
Type of Trades
Same Day Value
Trading Hours 9.00 a.m. – 3.00 p.m. Settlement Cut-off Time 5.00 p.m.(Monday to Friday)
Standard Value
Trading Hours 9.00 a.m. – 4.30 p.m Settlement Cut-off Time 11.00 a.m.(on Value Date)
Forward Value
Trading Hours 9.00 a.m. – 4.30 p.m. Settlement Cut-off Time 11.00 a.m.(on Value Date)
Holiday Convention for Government securities
The following table outlines how issue, coupon and maturity dates for government securities are adjusted for expected and unexpected holidays in Malaysia. Unexpected holidays occur rarely and is primarily due to the declaration of a previously non-gazetted public holiday by the Federal Government in response to unexpected events of national significance.
Unexpected Holiday on Tender Date and Issue Date
For interest payment, succeeding business day (may also be the same day as the issue date) Succeeding business day (only first interest payment is adjusted) For issue date, succeeding business day (only first interest payment is adjusted)
If both tender and issue dates are unexpected holidays, both dates shall fall on the next business day, with adjustment on tenor and calculation on proceeds. The maturity date is not adjusted.
Expected Holiday on Interest Payment and Redemption Date
For interest payment, succeeding business day (regardless whether crossing into the next month) For redemption, succeeding business day (including the last interest payment date or secondary note[SN] maturity date)
Unexpected Holiday on Interest Payment and Redemption Date
For interest payment, succeeding business day (including SNs maturity dates) For redemption, succeeding business day
Interest unadjusted. Interest period shall be based on the fixed interest dates i.e. no good value for any expected or unexpected holiday.
Rules on Delayed Delivery and Failed Trades
In the settlement process for securities transaction via the DvP system, it is possible for either buyer or seller to be the cause for the delay or failure to settle. Any settlements after the official RENTAS cut-off time are deemed to settle on the next business day.
By definition, delayed settlement occurs if settlement is executed after the official cut off time for the relevant trades on the value date e.g. trades settled after 11.00 a.m. for standard value trades. If settlement did not occur by closing of business day during the value date of the trade, this is then classified as a failed settlement. The delay or failure to settle a securities transaction within the stipulated cut-off time may result in a cascade of other delays or failures under the RTGS settlement environment, which may attract follow-on penalties imposed by the aggrieved parties which may include Bank Negara Malaysia. If the first aggrieved party can be proven to be directly responsible for the chain of further delays and failures, any compensation paid to the other aggrieved parties down the chain of transactions shall include the payment of penalties imposed by Bank Negara Malaysia.
The Difference Between Delayed vs. Failed Delivery of Securities Transaction
Delayed Settlement
Definition
• Settlement executed on the value date but after the official cut-off time
Notice
• The seller should notify the buyer by 2.00 p.m. on value date if funds are not received at or before the official cut-off time
• The buyer should notify the seller by 2.00 p.m. on value date if securities are not received at or before the official cut-off time
Impact
• The delay to settle a securities transaction within the stipulated cut-off time may result in a breach of the Central Bank’s operational requirement
Buyer at fault
• The seller has the right to claim from the buyer, the loss of interest on the amount due
Seller at fault
• The buyer has the right to claim from the seller, compensation on the amount due
Failed Settlement
Definition
• Settlement is not executed by the closing time on the value date
Notice
• The seller should notify the buyer by 9.30 a.m. the next business day if funds are not received at the close of the business day on value date
• The buyer should notify the seller by 9.30 a.m. the next business day if securities are not received at the close of the business day on value date
Impact
• The failure to settle a securities transaction within the stipulated cut-off time may result in a breach of the Central Bank’s operational requirement
Buyer at fault
• The seller will have to hold the securities until the settlement is completed. The seller could subsequently claim the interest/dividend or recalculate the proceeds to reflect the additional holding period
• The seller has the right to execute the sell-out
Seller at fault
• The seller will not be able to claim the accrued interest or the price change due to the shorter tenure
• The buyer has the right to execute the buy-in
International Clearing and Settlement
Scripless securities including Malaysian government securities can also be settled internationally via major global custodian banks and International Central Securities Depositories (ICSD) such as Euroclear and Clearstream. Both these ICSD currently appoint selected Authorised Depository Institutions, who are clearing members in RENTAS as their respective clearing agents in Malaysia. The settlement bridge between Euroclear and Clearstream is not normally used for Government securities. Non-residents or offshore investors may also individually appoint Authorised Depository Institutions who are RENTAS members to be custodian of their investments. Most financial institutions are also members of Society for Worldwide Interbank Financial Telecommunication (SWIFT), which facilitate the efficient transmission, and confirmation of cross-border payment and settlement instructions in foreign currencies.
HEDGING
Hedging Interest Rate Risk
Bursa Malaysia Derivatives Berhad operates, among others, the futures market for Malaysian Government Securities (MGS) and the Kuala Lumpur Interbank Offer Rate (KLIBOR). Bursa Malaysia Derivatives Berhad is governed by the Futures Industry Act 1993 and falls under the supervision of the Securities Commission (SC). Trading on the Exchange offers the security of trading with a regulated entity that is equipped with the necessary infrastructure and governed by regulations comparable to that of established markets worldwide. Futures contracts enable investors to hedge short-term or long-term interest rate risks of holding bonds or any investment in the Malaysian capital market. The following derivative instruments are listed and traded on Bursa Malaysia Derivatives Berhad :-
i) 3-month KLIBOR futures contract
Underlying instrument is the ringgit interbank time deposit in the wholesale money market with 3-month maturity on a 360-day year. Quarterly cycle contract months are March, June, September and December up to five years ahead and two serial months
ii) 3-year MGS futures contract
Underlying instrument is the 3-year MGS. Contract months are four nearest quarterly cycle months (March, June, September and December)
iii) 5-year MGS futures contract
Underlying instrument is the 5-year MGS. Contract months are four nearest quarterly cycle months (March, June, September and December)
iv) 10-year MGS futures contract
Underlying instrument is the 10-year MGS. Contract months are four nearest quarterly cycle months (March, June, September and December)
The 3-year, 5-year and 10-year MGS contracts carry a hypothetical coupon rate of 6%, and the yield is derived from the weighted yields of all eligible MGS in the basket. The weightage is announced by the Exchange. Notional amount per MGS Futures contract is RM100,000. Eligible MGS must meet the specifications of the respective bond derivatives contracts. Upon maturity, all bond derivatives are settled in cash terms using a final settlement value. The final settlement price is calculated from the final yield in accordance with the following formula rounded to two decimal points. Price = [(C/Y) [1 - (1 + Y/2)-2N] + (1 + Y/2)-2N] * RM 100
Hedging of interest rate risks can also be undertaken using the following over-the-counter (OTC) derivative transactions with onshore banking institutions:- i) Interest rate swaps ii) Interest rate swaptions, caps and floors iii) Bond options
Hedging Exchange Rate Risk
Non-resident investors are free to hedge exchange rate risk from investments through forward foreign exchange or foreign exchange derivative such as currency options and cross currency swap with any licensed onshore banking institutions.
Standardisation of Swap Documents
Financial derivatives transactions generally involve a contract between two parties to fulfill a mutually agreed obligation in the future. Therefore, all contracts need to be legally documented to avoid disagreement or default in the future. As the market volume of transactions increases, a standard document is necessary to act as the terms of reference. The widely accepted market standard is the International Swap & Derivatives Association, Inc. (ISDA).
REGULATORY AGENCIES AND MARKET INSTITUTIONS
Bank Negara Malaysia
Bank Negara Malaysia is the central bank for Malaysia. It was established on 26 January 1959 under the Central Bank of Malaya Ordinance, 1958, with the following objectives:
1. To issue currency and keep reserves safeguarding the value of the currency;
2. To act as a banker and financial adviser to the Government;
3. To promote monetary stability and a sound financial structure; and
4. To influence the credit situation to the advantage of the country.
Over the years, the roles and responsibilities of Bank Negara Malaysia have evolved and expanded. Today, Bank Negara Malaysia focuses on the three pillars of central banking, namely monetary stability, financial stability and the payment system. In addition, importance is given to the developmental role of Bank Negara Malaysia, in respect to economic management, institution building and the development of the financial system. To enable BNM to meet its objectives, it is vested with comprehensive legal powers under various Acts and Ordinances to regulate and supervise the financial system. These Acts include, among others, the Central Bank of Malaysia Act 1958 (Revised-1994), or CBA which is a revision of the CBO; the Islamic Banking Act 1983; Banking and Financial Institutions Act 1989 (BAFIA); Insurance Act 1996, etc, empowers the Central Bank to license and regulate institutions comprising of banks, finance companies, merchant banks, discount houses and money brokers, which constitutes the majority of market participants in the domestic bond market.
As the banker and adviser to the Government, Bank Negara Malaysia's business includes managing the liabilities of the Government, both in Malaysia and abroad. It advises the Government on its loan programmes, including planning the Government securities auction calendar, taking into considerations the terms and timing of the loans and issue of new types of securities. Bank Negara Malaysia participates actively in the monthly Cash Flow Committee meeting chaired by the Treasury to discuss the final details of Government securities issuances. In addition, Bank Negara Malaysia is responsible for trading, registering, settlement and redemption of Government securities through the automated trading and settlement system developed by the Central Bank.
It is stipulated in the Central Banking Act 1958 (Revised 1994, 2006) that Bank Negara Malaysia can provide temporary advances, known as "ways and means" advances, to the Government to cover any deficit in the budget revenue. However, there are legal limitations to the amount and the duration of loans that Bank Negara Malaysia can make available to the Government. As a result, the Central Bank's holding of MGS is minimal. Since 2005, Bank Negara Malaysia is allowed to purchase MGS from the primary and secondary markets based on market prices and to use the purchased securities for its open market operations. To ensure that these purchases do not unduly influence or distort market prices, Bank Negara Malaysia's participation in the primary auction is based on the weighted average price of the auction and is limited to a maximum of 10% of the issue size. Similarly, the amount purchased in the secondary market is limited to 10% of the outstanding issued amount. As at end-June 2006, Bank Negara Malaysia holds less than 1% of total MGS outstanding amount.
Securities Commission
The Securities Commission (SC) was established on 1 March 1993 under the Securities Commission Act 1993. The SC is a self-funding statutory body with investigative and enforcement powers. It reports to the Minister of Finance and its accounts are tabled in Parliament annually. The SC's many regulatory functions include:
a) Supervising exchanges, clearing houses and central depositories;
b) Registering authority for prospectuses of corporation other than unlisted recreational clubs;
c) Approving authority for corporate bond issues;
d) Regulating all matters relating to securities and futures contracts;
e) Regulating the take-over and mergers of companies;
f) Regulating all matters relating to unit trust schemes;
g) Licensing and supervising all licensed persons;
h) Encouraging self-regulation; and
i) Ensuring proper conduct of market institutions and licensed persons.
The SC administers the Securities Industry Act 1983 which governs a substantial part of activities in the domestic bond market. The SC also has the ultimate responsibility of investor protection. Apart from discharging its regulatory functions, the SC is also obliged by statute to encourage and promote the development of the securities and futures markets in Malaysia.
Regulation of Government Securities Market
Dealing in the government securities is a regulated activity under the Securities Industry Act 1983. Government securities dealers are typically banking institutions licensed and regulated by Bank Negara Malaysia. Besides banking institutions, universal brokers are also participants in the interbank market in government securities. The Malaysian Code of Conduct for Principals and Brokers in the Wholesale Money and Foreign Exchange Markets issued by Bank Negara Malaysia sets out the market best practices, principles and standards to be observed in the Malaysian market. The objective is to uphold market integrity and promote highest level of professionalism.
In addition, Bank Negara Malaysia also issued other rules and guidelines governing the issuance, allotment, interest payment, redemption, settlement and trading of scripless securities under Real Time Electronic Transfer of Funds and Securities (RENTAS) system. The aim of these guidelines is to provide a uniform set of rules to regulate and supervise the conduct of market participants as well as to promote market transparency. More information on the rules and guidelines issued by Bank Negara Malaysia can be obtained from the Fully Automated System for Issuing/ Tendering (FAST) website at https://fast.bnm.gov.my/fastweb.
Principal Dealers
The Principal Dealership system was introduced since 1989. Under this system, Bank Negara Malaysia appoints on an annual basis selected banking institutions as Principal Dealers (PDs) based on a set of criteria, including their capabilities to handle large volume transactions as measured by their shareholders’ fund, their secondary market trading volume and the overall risk management capabilities. The PDs are obliged to participate actively in the primary and secondary market, to bid for at least 10% of the instruments specified in the primary auction (MGS, GII, MTB, MITB) and to provide reasonable two-way price quotations under all market conditions in order to ensure liquidity in the secondary market. In addition, the PDs are also required to assume the following responsibilities:
1) Bid for MGS papers on behalf of clients at primary issues;
2) Intervene on behalf of Bank Negara Malaysia when needed;
3) Bid at least 10% in money market tender or repo auction conducted by Bank Negara Malaysia; and
4) Maintain minimum 5% share of secondary traded volume.
In return, to reward the PDs for the greater responsibilities entrusted on them, they were granted certain privileges, such as:
1) Allowed to be both borrower or lender under Securities Borrowing and Lending Guidelines;
2) Able to net off actual holdings of securities from Eligible Liabilities base;
3) Able to on-sell securities received via reverse repo for purpose of market making and hedging activities; and
4) Allowed to amend customer bids submitted to FAST of primary issuance.
With the PD system in place, secondary trading in the bond market has improved significantly. As at end-June 2006, there were 10 principal dealers in the Government securities market.
Other Market Intermediaries
Commercial banks, merchant banks, discount houses, Cagamas Berhad (the national mortgage corporation) are other approved interbank institutions that are allowed to deal in the interbank market. These institutions are not obliged to quote continuous two-way prices, however they are encouraged to participate actively both in the primary auctions and in secondary market trading. Investors can also appoint non-PDs to act as agent to buy and sell securities in the interbank market. Non-PDs may also be Authorised Depository Institutions (ADI).
Money Brokers
There are eight money brokers in the Malaysian market currently, in charge of arranging deals between two or more approved interbank institutions. Money brokers may also arrange deals between banking institutions and foreign counterparties in the international money market. Money brokers charge brokerage fees for services provided.
Shariah Advisory Council
To ensure all Islamic capital market products are in compliance with the Shariah principles, the Shariah Advisory Council (SAC) was established in 1996 by the SC for the onshore market. The SAC comprises prominent Shariah scholars, jurists and market practitioners and their role is to advise the SC on matters relating to the Islamic capital market and to provide Shariah guidance on Islamic capital market transactions and activities.
Bond Pricing Agencies
In January 2006, the Securities Commission (SC) issued guidelines for the introduction of bond pricing agencies (BPA). The objective of BPA is to provide daily independent and objective fair value for all ringgit denominated bonds, and to facilitate daily mark-to-market valuation of bond portfolios. On 18 April 2006, Bondweb Malaysia Sdn Bhd was registered as the first bond pricing agency in Malaysia. Currently, Bondweb Malaysia provides daily individual stock level valuation for more than 1,800 bonds in the domestic market.
LINKS
[1] BondInfoHub website of Bank Negara Malaysia
[2] Islamic Money Market Website of Bank Negara Malaysia
[3] Guidance Notes on Repurchase Agreement Transactions issued by Bank Negara Malaysia
[4] AsiaBondsOnline website of the Asian Development Bank
[5] Malaysian Government portal site
[6] Foreign Exchange Administration Policies of Bank Negara Malaysia
[7] Bank Negara Malaysia (Central Bank of Malaysia)
[8] Securities Commission of Malaysia
[9] The Treasury Department of the Ministry of Finance, Malaysia
