Muhammad bin Ibrahim: Labuan IBFC - past, present and future
Speech by Mr Muhammad bin Ibrahim, Governor of the Central Bank of Malaysia (Bank
Negara Malaysia), at the Labuan Industry Annual Dinner 2016 "Labuan IBFC: Past, Present
and Future", Kuala Lumpur, 27 October 2016.
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Introduction
Thank you for the opportunity to speak here at the 2016 Labuan Industry Annual Dinner. It is
a pleasure to share some of my thoughts tonight with the industry players here. Since its
inception 26 years ago, we have all played a part in developing Labuan IBFC into what it is
today. You have had a hand in its past, and you have indeed shaped its present. But the
global operating environment has significantly changed, and Labuan like any other
international financial centre needs to adapt to this new reality. Winds of change are upon us,
and will only blow harder as we move forward. This will, I anticipate, alter Labuan's role as
events around the globe continue to shape its future.
Drawing on tonight's theme "Bold and Beautiful", let us not shy away from asking the bold
questions facing Labuan IBFC and its future. I believe that successful and actionable plans to
secure the industry's future can only stem from us collectively and bravely confronting the
truths, however harsh or inconvenient.
With this in mind, my remarks tonight will focus on three areas:
• reflections on the evolution of international financial centres over the last few years;
• the imperatives for change; and
• possible strategies for Labuan's next level of development.
Travelled waters: The historical emergence of international financial centres
The historical emergence of international financial centres is closely linked to the use of
strategies to improve the efficiency of doing business and tax planning. International financial
centres were developed over many decades. Cultivated piece by piece around the globe,
strategies were put in place to enable businesses to be conducted more easily, more
efficiently and more profitably. Let me briefly attempt to recount the historical milestones to
contextualise the environment that we are now facing.
As far back as the 1880s, the American state of New Jersey liberalised its business
registration laws to attract corporates to register there. The success of this approach, at a
time of highly restrictive incorporation laws was then emulated by the state of Delaware. In
1929, the British courts ruled that an Egypt-based company registered in London was not
subject to British taxes since it did not conduct any activities in the UK. This significant ruling
set a precedent for the tax treatment of non-resident corporates, not only for the UK, but for
the entire British Empire. In 1934, Switzerland introduced laws that strictly upheld bank
secrecy, criminalising offences and limiting information shared with third parties. These
various events introduced elements that attract businesses such as ease of company
incorporation, advantageous tax treatment, sheltered offshore operations, and safeguarded
confidentiality and secrecy.
These elements had the effect of reducing the costs and improving the ease of doing
business. Until recently, these elements formed the cornerstone of modern international
financial centres.
International financial centres proliferated in the 1960s and 1970s with the emergence of the
offshore interbank market - or Eurodollar market - in London. Banks were allowed to carry
out largely unregulated deals as long as these were in foreign currency and between
nonresident clients. The development of the Eurodollar market in London proved to be the
principal force behind an integrated offshore economy. Jurisdictions with close links to
London - British Crown dependencies and former colonies such as Hong Kong and
Singapore - quickly latched onto this development and opportunity.
From this quick glimpse to the past, we can see that the emergence and growth of
international financial centres is a testament to human resourcefulness and ingenuity.
Opportunities have been quickly seized upon, and barriers have been promptly overcome. In
particular, businesses are continuously able to find innovative solutions in search of a
brighter future. This is an important lesson. To secure Labuan's future, we will need to call
upon this resourcefulness and ingenuity.
Changing tides: Developments shaping international financial centres
Beginning in the 1990s, the attractiveness of international financial centres began to evolve
following the wave of liberalisation and deregulation. Industrial countries also began offering
incentives similar to those available in international financial centres. It is perhaps at this
point of the evolutionary journey that the paths of international financial centres began to
diverge. Some continued to work towards stronger standards of regulation and supervision,
while others resorted to the use of less stringent regulations and opaque structures. The
latter, unfortunately, gave rise to the perception of international financial centres as shadow
centres that harbour unscrupulous financial activity.
The mid-nineties to the millennium were the defining years for international financial centres.
In the aftermath of the financial crisis and the ensuing economic slowdown, pressures began
to mount for international financial centres to tighten laws and adhere to international
standards on disclosure and transparency. Efforts against international tax avoidance and
money laundering intensified and have since proliferated across the globe, with initiatives
such as the Common Reporting Standards and the Base Erosion and Profit Shifting (BEPS)
measures. The Financial Action Task Force (FATF), of which Malaysia is a member, has also
been instrumental in driving stronger safeguards that protect the integrity of the financial
systems.
This is a positive development for us in Labuan as the business activities here have always
been developed and held to high regulatory and supervisory standards that promote sound
and transparent operations.
These regulatory developments now evolving around the globe will likely lead to different
business models for international financial centres. With the expansion of global agreement
and coordination in areas such as tax harmonisation and regulatory upscaling, privileges
such as tax incentives and secrecy will eventually cease to be competitive differentiators.
International financial centres will need to metamorphose into "new environment relevancy"
in order to survive these changes.
Value propositions will need to be rethought, anchored on new expectations amidst a new
operating environment. Indeed, we are already seeing other jurisdictions repositioning
themselves - drawing on real talent and specialisation, leveraging on infrastructure both
"hard" and "soft", and diversifying into other business segments ranging from arbitration
services to medical tourism.
Sink or swim: Repositioning Labuan IBFC
In a world where cross-border funds are shifting in significant volumes, where rules are being
rethought, where advancing technology is rapidly redefining the nature of financial
transactions, we must ask ourselves the important question of how we should respond to
remain relevant as an international financial centre. Sink or swim - such is the imperative of
Labuan IBFC's continued success, or even existence.
Although modelled and adapted after other international financial centres, Labuan IBFC was
always envisioned to benefit from overall growth and economic development in the region.
Today, it has become a centre for players in niche financial services such as aircraft and oil
and gas leasing services, reinsurance and captive insurance.
Nevertheless, the mandate to focus on out-out business still has much room for
improvement. Labuan was initially given the flexibility to accept domestic business to give it a
head start. It was never the intent to make domestic based business a focal point. And yet, at
present, almost half of the insurance business here originates from Malaysian risks.
Similarly, for the banking sector, over half of bank deposits here are derived from Malaysian
residents. In fact, loans to Malaysian residents have more than doubled the last five years
from USD5.9 billion in 2010 to USD12.9 billion in 2015. Such loans now account for 40% of
Labuan's total loans outstanding. This increased reliance on domestic business runs contrary
to the central theme of Labuan IBFC's global ambition. The reinvention of Labuan going
forward should not lose sight of its original vision.
Returning once again to tonight's theme, "Bold and Beautiful", let us confront some of the
bold questions about Labuan:
First, and fundamentally, with the Island in close proximity to long established global
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financial hubs, what could we offer that other global hubs could not? In short, what
sets Labuan apart? We need to find a differentiator.
• Second, with other international financial centres now strengthening their own
unique value propositions beyond tax privileges and confidentiality, what strategies
should we adopt?
• And the third question relates to us as industry players. Are we prepared to face the
winds of change? Do we have the resources and expertise in place to contribute
meaningfully so that as a collective we can reposition Labuan for the new
environment?
Allow me to share some thoughts on what is in store as Labuan moves forward into new and
competitive territory.
Strategies to reposition Labuan IBFC
First, we need to rethink on how Labuan IBFC can develop a distinct value proposition that
distinguishes itself from other competitors, as well as from the onshore market. To its credit,
the centre has already embarked on this journey by repositioning itself from an "offshore
centre" to a "midshore centre" over the past few years. As a "midshore centre", it offers both
the ease of doing business found typically in offshore centres, combined with high
international standards of regulation and supervision found onshore.
We now need to further refine the "midshore centre" concept by moving away from
broadbased financial services already widely offered and available onshore, to focus on niche
areas with high growth potential.
These include leasing, captives, commodity trading and wealth management. These areas
have continued to show an upward trend in driving the centre's growth in recent years.
Wealth management, in particular, offers a unique value proposition given that it is the only
international financial centre in Asia to offer private foundations and special purpose trusts,
including Islamic foundations or waqf. In the insurance space, the increasing interest among
corporates to establish captives as a risk management strategy presents immense
opportunities to offer risk solutions that complement the onshore activities. This strategy of
developing specialised areas would minimise overlaps and maximise complementarities
between financial services offered by the onshore market and in Labuan IBFC. I am
confident that with proper planning and execution, the "midshore centre" concept could very
well be a game changer.
On the part of the industry, much more needs to be done. Rates of retention for Malaysian
risks in Labuan have been steadily declining from 66.2% in 2011 to 57% in 2015. Retention
for offshore risks also reduced from 76.9% to 72.7% during the same period. The
optimisation policy, which accords the centre a preferred status after optimising onshore
insurance capacity, places a strong expectation for insurers here to maximise retention of
premiums in Labuan. Many of the offices of international players here today only act as
conduits. This situation is certainly not satisfactory.
On the talent front, despite greater operating flexibility and lower regulatory costs, significant
investments to develop local capacity and human capital have not materialised. For many
institutions, the outfit here merely consists of a name and skeletal staff, with full-fledged
presence in other parts of the region. Hence, while business is booked in the centre, dealings
and technical support are provided by regional offices where the experts reside. This is not
what the founders of Labuan IBFC envisioned and certainly detrimental to the best interest of
Malaysia. Industry players should seriously rethink about leveraging on the strength and
opportunity here to review Labuan's business strategies. And I suspect leveraging on ICT
would enable us to discover new opportunities, lower transaction costs and improve
efficiency and productivity. This is especially relevant given the emergence of fintech that will
alter the way financial services is delivered. Labuan IBFC can seize this opportunity to carve
its own niche in this new area.
Secondly, the regulatory regime of Labuan IBFC must continue to subscribe to high
international standards of regulation and supervision. Policies and regulations must be
facilitative of business and proportionate to risks. A well-defined regulatory framework, highly
competent supervisors, as well as closer engagements with home and host authorities are
key enablers to maintain a balanced regime that promotes the stability and integrity of the
centre. This prevents our industry from attracting undesirable activities and elements.
I should also highlight that a tax review exercise is currently in the works to harmonise the
tax regime of Labuan IBFC with the national tax system.
This will better align the centre with international efforts to arrest tax evasion and profit
shifting, whilst preventing leakages of tax income accruing to the nation for transactions
involving residents. With this review, we can expect tax rules and regulations that are more
levelled with the onshore market for transactions involving residents. We should envisage
that business transactions involving non-residents will continue to be incentivised to ensure
continued competitiveness of the financial sector here. Measures to streamline regulations
between the domestic market and Labuan IBFC will provide greater confidence and certainty
to international businesses and investors, benefitting both the onshore and offshore markets.
There is also a need to elevate the level of connectivity between Labuan, the rest of Malaysia
and the region to better facilitate economic and financial linkages. As an international
financial centre, connectivity is one of the most important measures of competitiveness.
Connectivity increases the probability of success. If we harbour ambitious plans and
aspirations for Labuan IBFC, we need to continue expanding its role in facilitating
crossborder investment and financial flows and we need to improve infrastructure. This requires
additional investment in infrastructure - "hard" and "soft" - to increase the connectivity of the
island to levels comparable to the world's leading international financial centres.
While infrastructure development on the island has come a long way since the 1990s, more
can be done to enhance the connectivity between the island and mainland Sabah. This will
greatly unlock Labuan's vast potential and provide synergistic benefits to Sabah as well. It
will create spill over benefits to sectors such as tourism and retail businesses. Perhaps
several of these initiatives could include greater connectivity by sea or even a construction of
a bridge with the mainland. Regional connectivity will be enhanced via the Kota Kinabalu
International Airport. Further seaport development can also assist in diversifying Labuan's
economic model by positioning the Island as the preferred national offshore oil and gas port,
and even a marine hub that houses marine-related functions (such as specialist marine
insurance claims, underwriting and maritime training) given its strategic location along
international trade routes. Investment in faster internet connection is another imperative as it
will facilitate business interactions and improve general liveability.
Overall, better connectivity will not only benefit inbound access to the centre, but also
outbound access. Businesses based in the Island will thus enjoy access to the rest of
Malaysia and neighbouring countries. More specifically, given the establishment of the
ASEAN Economic Community last year, there is significant potential for Labuan IBFC to tap
into greater regional financial flows for economic development in the region.
Initiatives undertaken by Labuan FSA
As the regulator of the centre, Labuan FSA has a critical role and continues to strive towards
ensuring that Labuan IBFC remains a vibrant and progressive business destination. Today, I
am pleased to announce three key policy initiatives that will be embarked upon in 2017:
• Firstly, the legal framework is being reviewed to better reflect regulatory and
supervisory policy intentions, as well as to ensure the legal requirements remain
relevant and current. This reflects the ongoing commitment of the centre to be a
leading jurisdiction in advocating strong prudential, transparency, anti-money
laundering and counter terrorism financing standards. The new legal settings will
allow international players to enjoy jurisdictional neutrality, while operating in a
sound and stable environment;
• Secondly, Labuan FSA will deploy more efficient systems for regulatory reporting,
leveraging on technology. This will improve the timely access, accuracy and value of
information that is captured by Labuan FSA to support its work. The new system
also aims to provide for the ease of reporting and data exchange with other
stakeholders; and
• Thirdly, Labuan IBFC will implement the Inter-Governmental Agreement of Model
1B. This will facilitate compliance by financial institutions here to the Foreign
Account Tax Compliance Act (FATCA) and exchange information with the US. This
and other similar agreements will further strengthen the framework for international
cooperation and confidence in Labuan IBFC globally.
Moving Forward
The future of Labuan IBFC is inextricably linked with the broader Malaysian financial system.
Much needs to be done. We face the same waves and undercurrents. Any actions and
strategies undertaken with regards to the future of the centre, affect not only Labuan, but
Malaysia as a whole.
Collaboration of various stakeholders is essential. It is with this in view that the Labuan FSA
is collaborating with Bank Negara Malaysia, Labuan Corporation and the Ministry of Finance
to undertake a comprehensive positional review of the centre and the Labuan Island as a
whole. The outcome of this review, once finalised, will ensure that Labuan IBFC emerges not
only as a stronger international financial centre, but one with an enlarged role in the
Malaysian financial system and economy.
This is a bold journey with great promise. All of us here tonight need to give our best and
play our roles in transforming Labuan IBFC. With a shared vision and steadfast commitment
to common objectives and principles, together, let us steer our journey in unison to a better
destination.