Islamic finance: Malaysia goes global

Asiamoney, July 2008

What next for Islamic finance in Malaysia? The country has already established itself as a global leader, and the clear Asian leader, in the Islamic financial services industry. It has the most advanced, robust and comprehensive legal and regulatory framework for Islamic finance anywhere in the world; it dominates the global sukuk markets; and it has opened its doors to Islamic providers from all over the world to come to Malaysia, set up and compete. What comes next?

The next stage will involve bedding in the Malaysian International Islamic Financial Centre (MIFC), the attempt to bring the Islamic world to Malaysia; developing new products; and waiting for the country’s various educational initiatives to bear fruit. But more than anything, it will involve Malaysia trying to take charge of efforts to integrate the Islamic financial world.

For example, Malaysia’s Securities Commission is rolling out its new Islamic Capital Market Development Plan. In March, as part of that plan, it announced three new initiatives: strengthening partnerships through collaborative efforts, establishing an international advisory committee, and convening a semi-annual international Islamic capital market forum.

All of these initiatives in some measure involve Malaysia trying to take a leadership position in integrating Islamic markets. One example is a memorandum of understanding with Universiti Sains Islam Malaysia (USIM), the aim of which is to come up with the world’s first global compilation of fatwas, or Shariah rulings. The Securities Commission calls it a “milestone development” that “will provide academics and practitioners a single source of reference of all rulings culled from major jurisdictions around the world.” A first volume should appear by 2009 and it will eventually come in many languages. Another MoU, with Universiti Malaya, is to establish a visiting scholar programme.

This matters because of an increasing sense that the future of Islamic finance is being impeded by a lack of standardisation among Islamic nations in Shariah standards. That doesn’t matter while the industry is made up of a series of domestic industries that don’t interact, but as soon as one hopes to take Islamic finance cross-border, there is a need for greater harmony and certainly greater understanding of practices elsewhere in the world. For Malaysia, which aspires to be a hub for this cross-border world, it’s therefore imperative to get things moving. “Divergence of interpretation has not in the past impeded product development, and can in fact encourage innovation,” says Nor Rejina Abdul Rahim, managing director at Nomura Asset Management Malaysia. “But the fact remains, an operating environment needs standardisation.”

The new International Advisory Committee is supposed to help the Securities Commission, and Malaysia generally, in its efforts to implement these projects and to engage with the rest of the Islamic world. It’s a high-powered bunch: probably the two most significant Shariah scholars in the world, Mohamed Ali Elgari of Saudi Arabia and Nizam Yaqubi of Bahrain; Salman Younis, the MD of Kuwait Finance House in Malaysia; Iqbal Khan, from Fajr Capital in the UK and a former head of HSBC Amanah; and Abdulkader Thomas, President and CEO of SHAPE in the US (he is originally American) and Kuwait.

It’s this integration of markets that most heavily punctuates the public pronouncements from the Securities Commission and Bank Negara Malaysia. In May, speaking to Asiamoney and others at the Islamic Financial Services Board’s annual summit in Jordan, the Securities Commission’s chair, Dato’ Zarinah Anwar, put forward a proposal for greater capital market integration. “I believe that a strong case can be made for the integration of Islamic capital markets,” she said. “The integration of markets need not necessarily be bound by geography but rather by identity. The OIC [Organisation of the Islamic Conference, an association of 56 Islamic states] collectively form a substantial base that can be considered to logically offer a distinct Islamic brand value, for both market-based intermediation and financing activities.”

Zarinah says the OIC member countries between them have a population of 1.5 billion and a combined GDP, based on purchasing power parity, of US$7.7 trillion, which adds up to 12.8% of total world GDP. Yet these states have only 23 exchanges between them, covering 29 countries, and their combined market capitalisation, at around US$2 trillion, accounts for just 3.3% of global market capitalisation. “The contrast between economic and market development, with only half of OIC member countries having exchange operators, suggest the Islamic community has insufficient access to market mechanisms to fund domestic growth.” She has high hopes that, in remedying this imbalance, surplus savings should be recycled from some Islamic nations to finance economic development in other Islamic countries.

But how to do it? She calls for strong and active support from governments and regulators to create the right enabling environment so as to integrate Islamic capital markets. She wants better frameworks – or any framework – to allow cross border issuance and distribution of products, and she wants to establish bilateral and multilateral linkages to allow professionals to move around, formalise links between exchanges, liberalise market access and reduce friction on cross border transactions.

And here’s where we start to see the role Malaysia envisages for itself in this developing Islamic world market. Malaysia has been positioning itself at the centre of the cross-border movement for some time, and one sees this clearly in the issuance of its various global sovereign sukuks. The first one, launched in 2002, was deliberately listed not just in Malaysia (in Labuan) but also Bahrain and Luxembourg. In July 2007, a Shariah-compliant issue of exchangeable trust certificates from Khazanah, the investment arm of the Malaysian state, was listed in Labuan, Hong Kong, and Dubai’s DIFX, the stock exchange within the new Dubai International Financial Centre. Malaysia has also attracted GCC states to list their own sukuk in Labuan; and Malaysia recently signed the first mutual recognition agreement with the Dubai Financial Services Authority for cross-border distribution and marketing of Islamic unit trusts.

Another theme that Malaysian public figures tend to champion is the integration of the Islamic financial services industry within the conventional international financial markets. It’s one of the key objectives of the Islamic Financial Services Board, which is headquartered in Kuala Lumpur but is multilateral, and which spends its time issuing standards for Islamic finance and trying to persuade central banks in the Islamic world to ratify them. “Where Islamic capital markets are concerned rules should, as much as possible, be harmonised, in line with globally accepted standards and best practices,” says Zarinah. This, she says, can include benchmarking with IOSCO principles of securities regulation, adopting international accounting standards and promoting good corporate governance. “These efforts will increase the attractiveness of our Islamic capital markets on the basis of a common reference standard.”

It’s within this context that the Securities Commission’s venture to promote a guide to global fatwa should be seen. Malaysia – as one of the outliers in Islamic regulation, since the stringency of compliance is generally seen as lesser there than in the Gulf, reflecting the more moderate interpretations of the Sunni faith in Malaysia – wants to promote convergence and standardisation in order to create a more cohesive Islamic capital market, with Kuala Lumpur as its global hub.

In the meantime, the country’s institutions are working on product innovation. For example, later this month Bursa Malaysia, the country’s stock exchange, is expected to announce details of a series of new Shariah-compliant products. One is believed to be a method of running a hedge fund in a Shariah compliant manner. To an extent, this has already been done: groups in the US, notably Shariah Capital, have launched what they say are Shariah compliant hedge funds (see previous coverage in Asiamoney). But, while these products have been endorsed by leading Shariah scholars, nobody knows how they work and there is widespread cynicism in the Islamic and conventional world about their true compliance. Rumour has it that Bursa Malaysia is not only going to launch such a product, but explain how it works too.

Bursa Malaysia’s only public comment on this so far has been in trailers to a forthcoming Islamic capital markets conference in Kuala Lumpur in which it says it will “be talking about going forward with exciting new exchange based Shariah compliant capital market products that will be introduced by Bursa Malaysia in the near future such as commodity murabahah house (CMH) and [an] Islamic alternative to stock borrowing and lending.” From this, it appears that the new structure may not be a hedge fund mechanism, but something that mirrors its function.

Bursa Malaysia’s chief executive, Dato’ Yusli Mohamed Yusoff, was unable to speak to Asiamoney for this feature but when the author last interviewed him in February, he said the opportunity for the exchange in Islamic finance was “huge”.

“We see the Islamic capital market as another growth market that we want to be active participants in,” he said then. “We need to provide more products, to create more Islamic compliant instruments: we’ve had REITs, for plantations and for private hospitals; we’ve got an Islamic ETF, we launched an Islamic index together with FTSE and the bulk of our companies are Shariah compliant. We need to keep rolling out these kinds of products.”

Another area Malaysia will strive to develop is asset management. In one respect, it has already stolen something of a march here. According to Ernst & Young, there were 134 Islamic unit trusts in Malaysia by the end of 2007, enjoying a compound annual growth rate of 36% between 2003 and 2007 in terms of assets, compared to 24% for conventional funds. Mutual fund penetration generally is high in Malaysia, with funds under management equivalent to about 30% of nominal GDP, much higher than most Islamic peers. Mutual funds occupy a much bigger slice of the Islamic finance industry in Malaysia than they do elsewhere. Badlisyah Abdul Ghani, CEO of CIMB Islamic, says that the global Islamic funds management industry represents just 6% of the total of assets managed in a Shariah-compliant manner; within Malaysia, the figure is 24%.

CIMB is among the more sophisticated asset managers in the Islamic world, but Badlisyah sees a host of challenges and barriers to growth. He thinks research and data on Shariah compliant assets is scarce; human capital is limited; and Islamic acquisition finance and mezzanine instruments are not readily available enough. “Though there is an ample pool of investments, it is limited by poor Shariah screening processes,” he adds. And there aren’t enough products. “The number of Islamic products and innovative Islamic structures is currently very limited compared to conventional products,” he says.

The centrepiece of Malaysia’s open-minded approach to the world is the MIFC. This initiative, ratified by the government in 2006, basically opens the door for financial institutions (and not just banks but fund managers, insurers and various intermediaries) to set up in Malaysia and offer products and services in any currency to anybody, resident or non-resident. It seeks to make Malaysia a centre for origination, distribution and trading of Islamic treasury and capital market instruments, a centre for Islamic fund and wealth management, for currency Islamic financial services, for takaful, and for Islamic finance education and trading.

It’s early days to say if this will work. The enthusiasm with which Al Rajhi Bank, Kuwait Finance House and Asian Finance House have set up operations in Kuala Lumpur suggests that Malaysia will attract Middle Eastern institutions and assets to its shores, but in terms of becoming the unarguable world centre for a globalised Islamic finance industry, that’s going to take time to become clear. But with Malaysia now accounted for 60% of the US$100 billion global sukuk outstanding, according to Bank Negara Malaysia, there’s little doubting the place’s ambition.