IFR Asia Malaysia Islamic finance report: capital markets

IFR Asia Malaysia Islamic finance report – capital markets

The capital markets provide the clearest illustration of how entrenched Islamic finance is into the Malaysian mainstream.

As of May 2009, there were 848 Shariah-compliant securities listed on Bursa Malaysia – that’s 88% of the total, or 63.7% by market capitalization. The corporate sukuk market, while not quite as clear-cut, tells a similar story: in June 2009 there were RM167.8 billion of outstanding corporate sukuk, accounting for 58.2% of all outstanding bonds. It is, both on the local debt and equity side, the majority that is now Shariah-compliant.

“We continue to see rapid growth prospects ahead for our Islamic capital market,” says Zarinah Anwar, chair of the Securities Commission. “The main driver of growth will be the continued broadening and deepening of the market.” She points to liberalization in the capital markets, the attraction of international participants, and “a steady pace of innovation as the industry reacts to market demand for more sophisticated products” as examples of the foundations for further growth.

The sukuk market is where Malaysia really stands out: it is by far the biggest market in the world for sukuk, with more than 60% of the global outstanding total, and also the only place where there is a secondary market that trades in any meaningful way (although it should be said that in this, like several other areas relevant to capital markets securities, it is sometimes at odds with Shariah thinking in the Middle East; some think the secondary trading of sukuk is not consistent with Shariah law anyway). Like everywhere else, Malaysian sukuk issuance fell with the financial crisis. “With the difficult market conditions, sukuk issuance fell by almost half in 2008,” says Zarinah. “But the downturn has turned out to be temporary and we have actually seen quite a strong recovery with gross sukuk issuance in Malaysia amounting to more than RM39 billion from January to July 2009.” That’s more than double the same period in 2008. “There is clearly a strong demand for financing and it has been attractive to issue sukuk to tap the appetite for Shariah-based investments in Malaysia.” Trading, though, has slumped. “Trading in sukuk has been lacklustre so far this year as compared to previous years,” says Zarinah. “Malaysia has a well-developed institutional investor base for sukuk but current conditions are not favourable for active trading because of the large variation in the pricing of private sector credit risks.”

One interesting recent development has been a push by Bursa Malaysia to get sukuks listed on the exchange. Two – Petronas and Cagamas – have already done so, and in some scale: Petronas’s US$1.5 billion sukuk is one of the biggest ever launched, while Cagamas has listed all the outstanding sukuk and bonds under its five residential mortgage-backed securitizations, amounting to RM4 billion. Both were listed under a new listing rule that took effect on August 3 called an exempt regime basis, which allows the listing of sukuk and debt securities on the exchange by both listed and non-listed issuers, in a form that cannot be traded. The logic is that they provide greater transparency to investors.

“I am seeing a real change from the investor side,” says Raja Teh Maimunah Raja Abdul Aziz, who was appointed the head of Islamic Capital Markets in June – a new position, dedicated entirely to Islamic markets and with a reporting line straight in to the CEO, which is in itself an illustration of how seriously the exchange is taking Islamic finance. “When I was in the markets [she was previously at Kuwait Finance House] people would say there is no reason to list sukuk because we don’t trade it on the exchange. But from the investor perspective, with the high profile defaults from the Middle East, investor awareness is heightened. They want transparency, they want governance. I’m pitching that one way you can offer it is to come through an exchange: then you get regulated, reporting is required, and if any issues come up the stock exchange will take them on. Retail investors would soon appreciate that issuers are offering themselves to be regulated, and the issuers will get better pricing.”

This retail element is an interesting point. Retail is highly engaged in Islamic finance: Zarinah says that as of the end of 2008 over one million retail investors held 59% of the value of Shariah mutual funds, “so the outreach to retail investors has been extremely successful”. But she also says that sukuk are much more of an institutional story. Raja Teh would like to see retail engaged in this asset class too. “I’d like to see a retail trading regime, which is something we would have to work very closely with the Securities Commission on,” she says. “It would provide diversity to the investing public because they have equities and then they would have sukuk too. It would be a great diversification to their portfolio and it could be done.”

Sukuk issuance took a major step forward with the Petronas issue. All told Petronas raised $4.5 billion, with $1.5 billion of it in a sukuk, in the first instance of a dollar sukuk being launched out of Malaysia. The country clearly expects more of this and has created a new designation, emas, to brand foreign currency bonds and sukuks launched out of Malaysia.

On both the debt and equity side, Malaysia continues to innovate in Islamic finance. In August Bursa Malaysia and the Malaysia International Islamic Financial Centre launched Bursa Suq Al-Sila’, the world’s first Shariah-based commodity trading platform. This uses the Shariah principles of Murabahah, Tawarruq and Musawwamah to facilitate commodity-based Islamic financing and investment transactions, using crude palm oil (Malaysia’s key export) as the launch commodity. Bursa Malaysia will operate the platform through a subsidiary. In essence, it involves one party buying a commodity at a certain cost and selling it to a customer at a cost-plus-profit basis. The customer pays the amount and the profit back on a deferred payment basis, and sells the commodity back to the market on spot for cash. In this way, it involves the sale and purchase of real physical assets and is therefore Shariah compliant.

Zarinah says other areas of innovation have included developing Shariah-compliant Islamic stock lending processes, and expanding hedging tools where the underlying asset and derivative contract are both Shariah compliant, allowing them to be used to hedge risks on existing investments in equities, indices or commodities.

On the equity side, the launch of an Islamic exchange-traded fund, the MyETF Dow Jones Islamic Market Malaysia Titans 25, in January 2008 came with much fanfare, although Raja Teh suggests there is more to come in that area. “The ETF is doing OK, but it could do better,” she says. “It’s just the way it’s designed. I’m a believer indices have to be purpose built to be able to use them. We ought not to look at Shariah compliant stocks only as a parameter; you have to go down to yield and returns.” She says she is talking to a number of fund managers and investment bankers who have over-the-counter funds which track particular indices but are not exchange traded. “I feel those funds are ready to come to be traded over the exchange. They are more likely to be successful because the indices are tailor made to the group of investors fund managers are selling it to. It needs to be market driven: a product engineer can sit here and build it but when you try to sell it it doesn’t work in these difficult times unless you design it for investors. ETFs are great but there is a lot of room for improvement.”

Raja Teh says they have enjoyed greater success with real estate investment trusts (REITs). There are now three of these: the Al-‘Aqar KPJ REIT, launched by KPJ Healthcare, which became the first Islamic REIT in the world when it listed in 2006; the Al-Hadharah Boustead REIT, launched in February 2007, which was also the first Islamic plantation REIT worldwide; and Axis-REIT, launched as a conventional product but reclassified as the world’s first office/industrial Islamic REIT in December 2008 after being screened to demonstrate Islamic compliance. Others are expected to follow: the Qatar-listed property group Ezdan has been reported as planning to list an Islamic REIT in Malaysia, made up of Qatar-based assets.

“The Islamic REITs have done very well,” says Raja Teh. “They have performed better than the non-Islamic REITs. We are speaking to the market now, saying I believe very strongly that Islamic REITs would be the kind of products investors are looking for in times like this – safe, boring, defensive, and the yields are fairly stable.” She says she would like to “push other forms of non-property REITs.”

As with other areas, the imperative in the Islamic capital markets now is international. “We see significant opportunities for both ourselves and other markets to promote more cross-border Islamic flows so that we can consolidate liquidity across our markets,” says Zarinah. “Such collaborative efforts are critical to firmly establish the global Islamic capital markets.”