Adlin Zulkefli

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INTERNATIONAL ISLAMIC ECONOMIC SYSTEM CONFERENCE (I-iECONS 2021)

Islamic P2P Financing in Malaysia: Shariah Issues and Operational Challenges

Adlin Zulkefli

Masryef Advisory, Kuala Lumpur Malaysia Tel: +6011 21256190 E-mail: adlin.zkl95@gmail.com

Nurul Awfa Muhammad Noor Habibi

Masryef Advisory, Kuala Lumpur Malaysia Tel: +6019 5703063 E-mail: nurulawfa96@gmail.com

Abstract

P2P financing is a type of alternative financing made available for issuers and investors looking for a non-conventional way of raising funds as well as investing. Under the P2P arrangement, issuer will issue investment notes which will then be subscribed by investors representing their interest in financing the business. Islamic P2P financing is still relatively new where the first P2P player approved by the Securities Commission Malaysia started offering its Islamic product in February 2020. This paper aims to scrutinize the Shariah concept of Commodity Murabahah via Tawarruq adopted by P2P players in Malaysia, its issues and operational challenges. The methodology adopted by this research is inductive approach in finding classical and contemporary references, as well as analytical approach in relation to the Shariah concept adopted, its issues and challenges. This work is restrictive to P2P platform players in Malaysia governed under the Securities Commission Malaysia. As a conclusion, this paper highlighted several findings which includes; 1. Islamic P2P Financing in Malaysia adopts the concept of Commodity Murabahah via Tawarruq; 2. 18%p.a. is the maximum profit or interest rate outlined by the Securities Commission Malaysia whereby it may raise an issue if the mechanism of dual rate is adopted by the P2P players; 3. Late payment charges charged under the concept of ta’widh should belong to party that incur real cost in its effort of collecting back payment which does not necessarily have to be funder or creditor; 4. The exercise of qalb al-dayn upon restructuring is not quite feasible for P2P players for the lack of fund to execute new Commodity trading for the roll-over.

Keywords: Islamic P2P Financing; Shariah Law; Islamic Finance; Islamic Fintech.

1. Introduction

Peer-to-peer (P2P) financing is an alternative finance programme where it first started in 2005 (Alexander Bachman, 2011). This programme, as the name suggest, is a peer-to-peer method of financing by which it involves no intermediary mediating investors or funders and the one requesting for funds termed as issuer. Under this concept, investors will have more options and choices to invest their funds whereby investors are free to choose what type of business and the level of risk-reward they are willing to take (Mesut Piskin, 2019).

P2P and Equity Crowdfunding (ECF) platform providers in Malaysia are licensed and governed under the Recognised Market Operator (RMO) Guidelines issued by the Securities Commission of Malaysia (SC) in December 2015. As of December 2020, a total of RM199.23 million was successfully raised through 159 ECF campaigns and a whopping RM1.14 billion was raised through 15,862 P2P campaigns in Malaysia (Securities Commission Malaysia, 2020).

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According to (Fintech Malaysia, 2021), in 2020 Malaysia GDP stands at RM1,389 billion and the Digital Economy Contribution makes 20% of the total amount. The current data by (Fintech Malaysia, 2021) shows that the Fintech space is currently dominated by payment and e-wallet services players which makes up 20% and 15% of the total number of players respectively while Islamic Fintech is captured to be at 4%. This could be translated as limited options and untouched market segment for Muslim investors and issuers to venture into, taking into account Malaysia as a Muslim-dominant country.

2. Definition and Shariah Concept

This section will focus on describing the Shariah concept and process flows adopted in an Islamic P2P financing product in Malaysia. P2P financing in its most basic form is a debt-based instrument used by companies to raise funds by way of borrowing money from the public. On the contrary, ECF is an equity-based financing used by companies to raise funds which in return, investors are offered a stake in the company i.e., shareholdings (Rizqi Umar Al Hashfi, 2019). The difference of theoretical concept between the two leads to different Shariah principles adopted in product structuring for P2P and ECF.

Under the debt-based P2P financing, as guided by the Shariah law, all debt created by way of borrowing should only be repaid at cost and any addition to the principal imposed by the creditor to his debtor shall tantamount to riba/interest.

For the above reason, Islamic P2P players in Malaysia mainly adopt the concept of sale-based financing i.e., Commodity Murabahah via Tawarruq arrangement to deploy its Shariah-compliant funds. (Bank Negara Malaysia, 2013) defined Murabahah as a sale and purchase of an asset where the acquisition cost and the mark-up are disclosed to the purchaser. Tawarruq on the other hand is an arrangement which consists of two sale and purchase contracts whereby the first is the sale of an asset by a seller to a purchaser on a deferred basis. Subsequently, the purchaser of the first sale will sell the same asset to a third party on a cash and spot basis (Bank Negara Malaysia, 2018).

By adopting this concept, the issuer is no longer borrowing from the funders, instead the raising of funds is based on a sale contract (Murabahah Sale) which is permissible according to the Shariah Law as directed by the verse:

ۚ ﺎَﺑ ِّﺮﻟا َمﱠﺮَﺣ َو َﻊْﯿَﺒْﻟا ُ ﱠ� ﱠﻞَﺣَأ َو

- 2:275

But Allah has permitted trade and has forbidden interest

Under this arrangement, issuer will onboard P2P online platform and request for financing by issuing an investment note – this is where the process of securitizing the debt of issuers takes place. Investors, on the other hand will onboard the platform and invest by way of subscribing - providing funds - to investment notes issued by the issuer, hosted on the platform.

The parties involved under Islamic P2P financing structured using Tawarruq contract includes:

Issuer – request for financing by issuing investment notes;

Investor – invest funds by subscribing to investment notes;

P2P Platform Operator – host the marketplace and act as agent on behalf of issuers and investors in executing commodity trades for Tawarruq and collection of payments, and;

Commodity Supplier and Buyer – Supply and buy commodity.

2.1 Structure

The following is the structure of Commodity Murabahah via Tawarruq arrangement:

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Fig. 1. Commodity Murabahah via Tawarruq arrangement work flow.

Issuer and Investors register and onboard P2P online platform. Subsequent to issuer passes all KYC checks, investment notes are issued and made available on the platform and is open for subscription by investors. Investors subscribe to investment notes by pledging their funds which will be kept in an Islamic trust account tagged to issuer.

Once the funds collected met the minimum amount set by the issuer, the campaign is deemed successful. Investment notes is issued to investors and commodity trade will commence.

Investors through P2P platform as agent will buy Commodity worth the financing value from Commodity Supplier at cash.

E-certificate is issued evidencing the transfer of ownership from Commodity Supplier to P2P platform (on behalf of investors).

Investors through P2P platform as agent will subsequently sell the commodity to issuer at cost plus mark up on deferred payment basis. E-certificate is issued evidencing the transfer of ownership from investors to issuer.

The indebtedness is created and sale price shall be payable by issuer to investors upon maturity.

Issuer through P2P platform as agent will sell the same commodity to Commodity Buyer at cash. E-certificate is issued evidencing the transfer of ownership from issuer to Commodity Buyer.

Proceeds from such sale to the Commodity Buyer is credited into issuer’s bank account.

Upon completion of commodity trading and funds being credited into issuer bank account, the platform operator will generate a payment schedule depicting issuer’s payment obligations either via monthly instalments or bullet payment which shall be payable to investors upon maturity.

P2P Platform Operator

Investors Issuer

Commodity Buyer

Commodity Supplier Islamic Trust

Account

1. Registration & Onboarding

1. Registration & Onboarding

2. Buys Commodity in cash

3. Commodity 4. Sells

Commodity on deferred

5. Sale price payable upon

maturity

6. Sells Commodity in cash

7. Cash payment on spot

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While other Shariah concepts such as istisna’, salam and mudharabah may also be applicable in Islamic P2P financing depending on characteristics of products such as invoice financing, car dealer financing, takaful premium financing etc., this article only focuses on Commodity Murabahah via Tawarruq arrangement as adopted by a number of players in Malaysia which includes microLEAP§§§§§§§§§§, MoneySave*********** and CapitalBay†††††††††††. 3. Shariah Issues and Challenges

Section 3 aims to focus on a number of Shariah issues and challenges faced by P2P players in Malaysia in offering Shariah-compliant solution to the public. As abovementioned, this work is restrictive on issues and challenges encountered while adopting the Shariah concept of Commodity Murabahah via Tawarruq arrangement.

In this section, we will dive into several issues concerning dual profit rate mechanism, late payment charges and restructuring of the financing facility.

3.1 Dual Profit Rate Mechanism

As commonly adopted in the Islamic finance industry, dual profit rate mechanism is also commonly used in Islamic P2P financing. Under this structure, two profit rates are adopted in a single issuance of investment notes namely the contracted profit rate and the effective profit rate.

The contracted rate is a rate at which the Murabahah sale is contracted at i.e., the sale price while effective profit rate is a rate at which investors are expecting their returns. The sale price which is contracted at a contracted profit rate should always be higher than the effective profit rate. At the end of tenure, the difference between the contracted profit rate and the effective profit rate is given as ibra’ to issuer. This mechanism is adopted as a way to cater should there be a need for future rescheduling or restructuring of any issued investment notes.

Upon any rescheduling and restructuring activities, payment collection from issuer shall always be capped at the contracted sale price. Any payment collected above the sale price shall not be recognized as income to neither investors nor the P2P platform provider and such amount should be disposed of by way of channeling to charity.

The adoption of this mechanics greatly reduces risks for investors as well as issuers by providing ‘breathing space’ for issuers. In the event issuer faces difficulty in servicing its monthly instalments, there is room to provide for extension of period while retaining investors interests.

Issue arises when the maximum profit rate set by the Securities Commission Malaysia to P2P Operators is capped at 18% p.a. for all issuance which includes conventional and Islamic issuance (Securities Commission Malaysia, 2015). Under the dual profit rate mechanism, as the contracted profit rate should always be higher than the effective profit rate, in the event, an issuance is set at a high effective profit rate of 18%, this mechanism shall no longer be applicable as the contracted profit rate cannot be set at a rate more than 18%p.a. and should not be lower than the effective profit rate.

In this case, the investors are exposed to a higher risk as there will no longer be a ‘safety net’ to safeguard their interests in case the issuer is having difficulty in servicing the monthly instalments and requests for extension of period. Under a normal banking facility, a concept of roll-over will then be applicable to such facility. However, this concept faces new challenge as P2P operators are different from banks and other financial institutions in general.

The issue of roll-over will be discussed under sub-section 3.3 below.

Another possible solution to cater to this issue is by adopting a dual tenure mechanism where instead of contracting a dual profit rate for the facility, the agreement is contracted with a dual tenure. Similar to the abovementioned mechanism, in this case a contracted and an effective tenure are built in the agreement to cater for any request for extension when needed and same rebate mechanism may be adopted if payment is made on a timely basis.

§§§§§§§§§§ https://www.microleapasia.com/microleap-islamic/faq/

*********** https://moneysave.com.my/

††††††††††† https://capbay.com/faq-p2p/#1618900229264-9845f732-86d3

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Following the Islamic Finance industry in Malaysia, BNM and the SC has allowed charging of late payment charges as a deterrent measure to debtor as well as to safeguard the interest of creditor based on the hadith:

رﺮﺿ ﻻ راﺮﺿ ﻻو

No harm nor reciprocating harm

According to (Bank Negara Malaysia, 2017) late payment charges is allowed to be charged under the concept of ta’widh and gharamah. Ta’widh as defined by Securities Commission Malaysia (2020) refers to compensation that can be claimed by the creditor when the debtor fails or delays to perform its obligation to repay debt. This is established against some actual cost incurred by the creditors from failure of repayment. Gharamah on the other hand, refers to penalty imposed as a deterrent for late payment by debtor.

Under the above definition, the SC is only allowing creditors i.e., fund providers to charge late payment charges.

Being a P2P platform operator does not justify the criteria hence late payment charges under this definition are only allowed to be charged by investors being the creditor. However, under the P2P concept, even though creditors do provide funding, unsimilar to normal banking concept where the financier itself suffers the cost of any late payments from customers, investors under P2P financing, do not suffer real cost other than the opportunity cost. On the other hand, platform operator who will under these circumstances undertake the process of recovery such as sending reminder emails and phone calling do suffer and has to bear these costs being an intermediary and agent to investors.

As the concept of ta’widh is meant to compensate creditors on the cost incurred for collecting his money back, it does not concur when there is no costs involved. Will such collection then not be similar to riba/interest? To overcome this, the writer suggest there is a need for a specific rule and guidelines for the P2P players to adopt in relation to late payment charges. Suggestion includes by way of putting in place a clause under the platform agreement providing specifically for P2P providers to be able to recover its cost upon any late payment from the ta’widh provision and anything over and above real costs incurred shall be treated as gharamah.

Another issue in relation to the LPC is the rate at which the LPC is set. The SAC of SC only allows ta’widh to be charged at a rate of maximum 1% - during the tenure, or the IIMM rate – after maturity. Conventional investment notes contrarily are allowed to charge a higher LPC. This in turn may encourage those who have issuance via both islamic and conventional to default its payment obligation towards islamic notes first as the LPC charged is lower than conventional investment notes.

3.3 Restructuring of Facility by Entering into a New Contract

Rescheduling and restructuring are the common concept of adjusting and extending the period or tenure of a financing facility undertaken by financiers in order to accommodate debtors request due to financial constrains (Abdul Muneem, 2020). Different to restructuring, rescheduling for Islamic facility has been defined by many, such as Hasan. A. et al (2018), as an extension of time given to the debtor without concluding any new contract on top of the defaulted facility. To this definition, rescheduling for Islamic debt facility shall not involve any increase in the existing sale price i.e., established debt in which, if any, is tantamount to riba/interest.

Restructuring, on the other hand, usually involves changing terms which include the debt amount and the repayment tenure. To enable this practice for debt-based contracts, such as Murabahah, without any risk of incurring riba, the financier and the debtor will need to conclude a new Murabahah sale and use its proceeds to settle the old Murabahah debt, commonly known as qalb al-dayn.

With clear understanding of current restructuring practice, settling old debt using proceeds from new debt does not seem very practical for P2P financing under which the creditor in this case are public investors and not the P2P entity itself. On top of that, there are multiple investors cum creditors for one specific investment note. Practically in an Islamic financial institution such as Islamic banks, the bank will use its own liquidity to credit fresh money for the debtor to settle existing debt. However, in P2P cases, the fresh money needs to be injected by investors – either existing or new investors – as creditor to the issuer for the settlement of the outstanding sum.

Practically, this is only plausible if existing investors agree to inject new funds for the purpose of concluding new Murabahah to settle the outstanding debt towards themselves i.e., investors who agree to bring in new funds

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will be credited back the same amount after the Murabahah trade is executed, as settlement payment for the restructured notes in which case, if not explained properly may bring confusion to investors. Bear in mind that this may brings another issue in cases where not all investors agree to furnish to such request, P2P operator may need to source for new funds in order to satisfy the full payment obligation of the old debt. This new fund will translate into a new investment notes altogether of which the purpose of utilization of proceeds will then be as settlement payment for the restructured notes. This would not be an attractive investment option for new investors to come in which left us with only one possible option where P2P operators will need to step in and fund this transaction with their internal funds. Hence, the concept of restructuring for P2P financing may be quite difficult to be realized operationally.

4. Conclusion

Shariah contracts are indeed flexible and can facilitate innovations in this new digital finance area. However, there are a number of considerations and issues which need to be scrutinized when structuring Islamic products for the fintech players through their digital platforms. These considerations revolve around the platform operation, different regulations imposed by regulators on digital financing products and nature of the offered product itself. As digital innovations are mostly different to how Islamic banks work, a more robust guidelines in terms of Shariah practices needs to be put in place by Shariah Advisers advising fintech player in ensuring end-to-end confirmation of their business practices as well as operations to Shariah principles.

In conclusion, there are still rooms for Islamic finance practitioners to explore various contracts around digital finance beyond P2P financing. With the recent Initial Exchange Offerings (IEO) regulation in Malaysia and upcoming digital asset players looking to offer more financial products, Islamic finance should be developed further proactively as an alternative and to be able to stand side by side to its conventional counterparts, digging deeper into the realm of Shariah-compliant aspects of it.

References

Abdul Muneem, N. F. (2020). Issues on Restructuring of a Financing. Shariah Journal, Academy of Islamic Studies, Vol. 28 (No. 1(2020)), 105- 126. Retrieved from https://ejournal.um.edu.my/index.php/JS/article/view/24441

Alexander Bachman, A. B. (2011). Online Peer-to-Peer Lending -- A Literature. Journal of Internet Banking and Commerce.

Bank Negara Malaysia . (2017, December). Kompilasi Keputusan Syariah dalam Kewangan Islam Edisi Ketiga. Retrieved from Bank Negara Malaysia Web Site: http://www.sacbnm.org/wp-content/uploads/2020/02/Kompilasi-Keputusan-Syariah-Dalam-Kewangan-Islam_Edisi- Ketiga-2011-2017.pdf

Bank Negara Malaysia. (2013, December 23). Murabahah Policy Document. Retrieved from Bank Negara Malaysia Web Site:

https://www.bnm.gov.my/documents/20124/938039/20131223_S_O_0001.pdf/756c9ea2-9184-67d5-a227-a2fa00bef7c9?t=1592216491941 Bank Negara Malaysia. (2018, December 28). Tawarruq Policy Document. Retrieved from Bank Negara Malaysia Web Site:

https://www.bnm.gov.my/documents/20124/938039/pd_reissuancetawarruq_dec2018.pdf/bcc4b359-381c-5035-f9f0- 3908faebb92a?t=1592249563244

CapBay. (n.d.). FAQ for P2P Financing Platform. Retrieved from capbay Web Site: https://capbay.com/faq-p2p/#1592290349057-f1356434- 952f

Fintech Malaysia. (2021). Malaysia Fintech Report 2021. Malaysia: fintechnews.my.

Hasan, A., Haron, M., & Mana, B. (2018). Rescheduling and Restructuring of Islamic Financing Facilities: A Shariah Perspective. ISRA Research Pape(No.100/2018), p. 45.

Mesut Piskin, M. C. (2019). Islamic Online P2P Lending Platform. 3rd World Conference on Technology, Innovation and Entrepreneurship (p.

415). Elsevier B.V.

microLEAP. (n.d.). Retrieved from microLEAP Web Site: https://www.microleapasia.com/microleap-islamic/faq/

MoneySave. (n.d.). MoneySave. Retrieved from MoneySave: https://moneysave.com.my/

Rizqi Umar Al Hashfi, A. S. (2019). Exploring Islamic Peer-to-Peer Lending for the Unbankable. Airlangga International Journal of Islamic Economics and finance, 73.

Securities Commission Malaysia. (2015, December 11). Guidelines on Recognized Markets. Retrieved from Securities Commission Malaysia Web Site: https://www.sc.com.my/api/documentms/download.ashx?id=eb8f1b04-d744-4f9a-a6b6-ff8f6fee8701

Securities Commission Malaysia. (2020, December 31). Securities Commission Malaysia. Retrieved from https://www.sc.com.my/analytics/ecfp2p

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