Interest Schemes: Funding in a world post-SARS-Cov-2?

You may not be familiar with the term "investment interest schemes". But perhaps in a world post-SARS-Cov-2 where funding for businesses will became a challenge, you should. From my experience handling disputes relating to interest schemes, I set out my brief thoughts on interest schemes as an alternative form of fund-raising, especially for SMEs.

Commerce and capitalism always find a way to make a ringgit. As Sun Tzu said, opportunities can be found in chaos. One only need to know where to look.

In the aftermath of the 2008 financial crisis, business-minds in Malaysia searched for new means of funding, and of course, to make that ringgit. The model of “interest schemes” lit up on some radars, and we saw an uptick in interest schemes being set up over the years since. Nothing major that the concept became household, but enough that the Companies Commission of Malaysia decided in 2016 that more robust regulation was necessary.

History, in brief

Interest schemes existed in Malaysia, in some form or manner, since at least the early 90s. In the early days, such schemes were less sophisticated. They were, in the main, recreational memberships and time-sharing schemes. Fantastically, there is even a Federal Court judgment which expanded the definition of interest schemes to include purchase of burial plots, urns and columbarium niches offered by memorial parks.

In the past 10 years however, interest schemes in Malaysia became more sophisticated. Eventually, the adoption of interest schemes as a form of funding and investment product became more prevalent.

What is an investment interest scheme?

What are investment interest schemes? In a nutshell, these schemes are sponsored, set up and ran by management companies. Investors put money into the scheme, for a share in the interest or benefit arising from a scheme asset, business or operations – these are typically owned by the management companies. In return, investors can look forward to receive agreed dividends or yields (typically from the profits generated from such asset, business or operation). In colloquial terms, this amounts to a collective pooling of resources to run a business. In simple practical terms, schemes are used by companies as a form of funding, by being offered as an investment product.

Critically, investors do not buy shares in the management companies, but merely a right to a share in an interest or benefit. Such investors therefore have no direct control over the conduct of the management companies, nor a right to the scheme asset, business or operation itself. Relationship between investors and management companies are governed solely by the terms of the contractual documents, and the investors’ security usually lies only against the value of their interest in the scheme assets. As you can imagine, quite a sophisticated legal regime needs to be in place to govern such entities.

Before 2017, interest schemes were regulated under Division 5 of the now repealed Companies Act 1965. The increased sophistication of schemes eventually necessitated the introduction of the Interest Schemes Act 2016 and Interest Schemes Regulations 2017, which came into operation on 31 January 2017. The objective of this new regime was to provide better controls over interest schemes to protect investors.

Investment schemes: an attractive proposition for funding?

I cannot help but wonder, in the aftermath of this SARS-Cov-2 pandemic, will businesses train their eye once more on investment interest schemes as a source of funding? Before the pandemic, the Companies Commission of Malaysia in its Interest Schemes Blueprint 2020-2024 appear to be gunning for a push of interest schemes as a form of alternative financing, particularly for SMEs (see Chapter 4). Would this be given more focus in this aftermath?

Investment interest schemes can admittedly be an attractive option as:- (a) loan facilities from banking institutions become harder to come by; (b) offering investment schemes is more accessible to companies (especially SMEs) than public listing; (c) it allows company owners to retain equity; and perhaps more importantly in a post-SARS-Cov-2 environment where funds will be held closer and tighter; (d) large funding can be secured by “crowd” funding, i.e. low entry-level investments from many individuals.

Only time will tell. All I can say at this point is that investment schemes are not without their pitfalls. They are still at their relative infancy in Malaysia. We are still trying to identify the most effective commercial concepts and terms – the few schemes I have examined appear to be riddled with commercial deficiencies. There are still various teething problems with regulation. Indeed, the law is still new and relatively untested – in late 2019, I was involved in what appears to be the first and only reported Malaysian winding-up of a scheme.

Indeed, opportunities can be found in chaos. But, remember to enter with eyes wide open, please.