Interest scheme products vs Unit Trust and REIT products

Given the rapid growth of the interest scheme sector in Malaysia, it is necessary to understand the differentiating features of interest scheme products that are established under the Malaysian Companies Act 1965 and products such as unit trusts and REITs that are established under the Malaysian Capital Markets and Services Act 2007.

The table below shows a broad set of differentiating features:

No.	Feature	Interest scheme product	Unit trusts or REITs
1.	Applicable statute	Interest schemes falls under the purview of Section 84(1)(b) of the Companies Act 1967 (Act 125) (“Companies Act”) definition of “interest” which means any right to participate or interest, whether enforceable or not and whether actual, prospective or in any common enterprise, whether in Malaysia or elsewhere, in which the holder of the right or interest is led to expect profits, rent or interest from the efforts of the promoter of the enterprise or a third party. Interest schemes do not fall within the excluded categories under the definition of “interest” in Section 84(1) Companies Act. Interest schemes do NOT fall under the definition of “unit trust scheme” as contained Section 2(1) CMSA for THREE (3) reasons: i. Interest schemes have NOT been exempted from the operation of Section 84(1) Companies Act by the Minister of Domestic Trade and Consumer Affairs exercising his powers under Section 96(1) Companies Act; ii. The Minister of Finance must have made a prescription under Section 5 CMSA for the “interest” to fall under the operation of the CMSA; and iii.There are material differences in pith and substance between the interests created under the interest schemes and that of a “unit trust scheme” as defined in Section 2(1) CMSA. These differences are enumerated below in this Comparative Table.	For the Capital Market and Services Act 2007 (Act 671) (“CMSA”) to apply to any “interest” created, such an “interest” requires two positive statutory actions under the Section 2(1) CMSA definition of “prescribed investment”, namely: i. An interest as defined under subsection 84(1) Companies Act must have been exempted under Section 96(1) Companies Act by the Minister of Domestic Trade and Consumer Affairs; and ii. The Minister of Finance must have made a prescription under Section 5 CMSA. Section 2(1) CMSA also defines “prescribed investment scheme” as an undertaking, scheme, enterprise, contract or arrangement in relation to a prescribed investment. Although, Section 2(1) CMSA defines “unit trust scheme” to mean any arrangement made for the purpose, or having the effect, of providing facilities for the participation of persons as beneficiaries under a trust in profits or income arising from the acquisition, holding, management or disposal of– (a) securities; (b) futures contracts; or (c) any other property; there are material differences in pith and substance between the interests created under the proposed interest scheme and that of a “unit trust scheme” as defined in Section 2(1) CMSA. These differences are enumerated below in this Comparative Table.
2.	Intrinsic value	No intrinsic value - Interests carry a value derived from a direct contractual interest in a business managed by the Management Company that is protected by an underlying asset value.	Every unit of a unit trusts and REIT carry an intrinsic value.
3.	Active versus Passive Modality	Interest schemes are "common enterprise" schemes i.e. in the nature of mini joint ventures based on contractual rights. Due to their privity in contract, interest holders are more active participants. The Management Company in an interest scheme is appointed by interest holders to operate the business situated on the asset.	Investors of unit trusts and REITs are buying instruments that carry an intrinsic value independent of the business conducted by the issuer. They are passive investors. They are further removed from the actual business activity. Unit trusts pool funds from investors and then invests the funds in a portfolio of various investment mixes approved by the regulator.
3.	Tradeability	There is no separate legal instrument. Every transfer of an interest is, in fact, a novation or assignment of parties.	Unit trusts and REITs, are unitized instruments that bear an intrinsic value. The bearer of these instruments can publicly trade the unit trusts and REITs. They have better liquidity features. The character of tradeability is a key differentiating characteristic as shown by Section 2(1) CMSA definition of “unlisted recreational club” means a corporation which provides the holders of its shares or debentures the right to use or enjoy any recreational, holiday or other related facilities and whose shares or debentures are not listed or proposed to be listed for quotation on any stock market of a stock exchange.
4.	Ownership and interest	Typically the Management Company has the legal ownership of the asset. The Management Company undertakes to maintain the asset free of encumbrances. The interest holder has a direct beneficial interest in the asset.	In the case of REITs, the management company is usually separate from the owner of the asset. The owner of the asset under REITs is usually a special purpose vehicle established for the sole purpose of holding the registered title to the asset. Neither the unit trust holders nor REIT holders have a direct beneficial interest in the asset.
5.	Vesting	Interests are inchoate property interests i.e. property rights not vested / rights to property not completed but linked to the underlying property. Vesting takes place on a contingent basis i.e. where the Management Company’s role is taken over by the Trustee. Rights of interest holders are derived from the contract executed.	Investors of unit trusts and REITs are buying instruments that carry an intrinsic value linked to the value of the Issuer and, indirectly, to the Issuer's assets The underlying assets never vests with the investors. Rights of the unit trust and REITs holders are derived from the instrument itself.
6.	Share of profits versus financial yields	The “nett yield” paid to interest holders is actually a direct share of profits generated from the business conducted by the Management Company. Interests created under the proposed scheme, being mini joint ventures, generate profits that are then shared between and amongst other interest holders. However, to make it easy for participants to understand how their returns are calculated, interest schemes typically use a percentage of the base value contributed by the participants	Unit trusts and REITs use a computation formula to calculate yields which is further removed from the actual business activity. Unit trusts and REITs are, therefore, more akin to equity and financial products. In this respect, the yields from unit trusts and REITs are similar to bonds and, dividends paid to equity shareholders.