IFR Asia Malaysia Islamic finance report: International players

IFR Asia – Islamic finance Malaysia – international

In August 2006 Malaysia took a bold step. With the launch of the Malaysia International Islamic Financial Centre (MIFC), it was making a statement: that Malaysia’s domestic Islamic finance industry had grown strong enough to withstand the arrival of foreign houses, and that the only way to make the country the global hub it aspires to be was to let those foreign groups in.

MIFC isn’t just for international businesses – domestic houses too are encouraged to use the initiative as a platform for the launch of Islamic finance activities – but the greater significance of it was certainly the decision to open the doors and give new licences to foreign businesses. Launched by Bank Negara Malaysia, the Securities Commission, the Labuan Offshore Financial Services Authority and Bursa Malaysia, it was backed by everyone who matters in Malaysian policy, and offered generous incentives to bring foreign expertise and capital in. The idea is to create a global hub for international Islamic banking, takaful, fund management, sukuk origination and human capital development.

In fact, Malaysia had already been notably more open to foreign businesses in Islamic finance than in conventional banking for years. In 2004, Malaysia announced plans to license three Middle Eastern banks to set up Islamic operations.

Kuwait Finance House (see box) started out in 2005. It was followed by Saudi Arabi’s Al Rajhi, the world’s biggest Islamic bank by assets, which opened its doors in Malaysia in October 2006 with 12 branches in the Klang Valley and a vast retail marketing push – that year one could hardly find a lamppost in central Kuala Lumpur without the Al Rajhi logo on it. Al Rajhi at the time announced plans to get to 50 branches by 2010, and started out with a clear retail focus, offering current and savings accounts, charge cards, personal financing, fixed term investments and commodity murabahah. Finally, Asian Finance Bank, formed by majority shareholder Qatar Islamic Bank alongside Saudi Arabia’s RUSD Investment Bank and Kuwait’s Global Investment House, opened with an initial focus on corporate and investment banking, and in particular bringing opportunities back to clients in the Gulf.

Separately, three other foreign groups with a long-standing presence in Malaysia – HSBC (as HSBC Amanah Malaysia), Standard Chartered (as Standard Chartered Saadiq) and Singapore’s OCBC (as OCBC Al-Amin Bank) – are licensed Islamic banks in Malaysia.

As the forerunners to MIFC, how have they done? Al Rajhi has said it aims to grow deposits by 15% this year, to RM4 billion, and has already logged 100,000 customers through 19 branches. It has built a strong presence in project and structured finance, and is now active in advisory, Islamic debt arranging, corporate finance, asset management and brokerage. Kuwait Finance House in Malaysia grew assets by nearly half in 2009, to RMB9.64 billion, and almost doubled financing, advances and other receivables to RMB6.35 billion. And Asian Finance Bank, though less publicly visible, has been active in specialist areas, signing a RM50 million term financing with Onsys Energy to part finance the cost of two oil product tankers recently.

These banks were given a striking degree of latitude to do pretty much what they wanted in Malaysia provided it was Shariah compliant, and their home bases reflected a hope in Malaysia that excellence in Islamic finance could bring burgeoning Middle East liquidity (now somewhat diminished but still important) into Malaysia.

MIFC extended this hope but on a far bigger scale. And it has been active in granting licences, even if it will take time to see if they lead to international capital entering the country. Among international institutions, Al Rajhi is now licensed twice – in April 2009, it added an international Islamic banking licence under MIFC to the one it already held. Other foreign groups licensed as international Islamic banks within Malaysia are Unicorn International Islamic Bank, whose parent, Unicorn Investment Bank, is based in Bahrain; and PT Bank Syariah Muamalat Indonesia. Separately, Citibank, RBS and Deutsche Bank are all licensed as “Participating Banks in Islamic Banking Scheme,” according to MIFC. Among other things, banks under MIFC are entitled to apply to conduct foreign currency business.

Takaful has also seen a number of international groups licensed within MIFC, either in partnership (such as CIMB Aviva Takaful) or largely in their own name (HSBC Amanah Takaful, Prudential BSN Takaful). But it is perhaps in asset management that the clearest effort and progress is being made to court foreign groups, because here, unequivocally, the state has put its money where its mouth is. Not only are global fund managers allowed to set up 100% foreign-owned Islamic fund management operations in Malaysia; given withholding tax exemptions on profits from Malaysia-originated exemptions; and allowed to invest all their money outside Malaysia if they want to. In addition the government has committed $2 billion of the Employees Provident Fund’s money as seed capital for new Islamic asset managers in MIFC.

So far seven have been licensed and they all involve some degree of foreign ownership. The first were Kuwait Finance House, DBS Asset Management, CIMB-Principal Asset Management, Global Investment House (from Kuwait), and Reliance Asset Management. DBS was already a partner in a conventional Malaysia enterprise, Hwang-DBS Investment Management; in December the two groups jointly launched a global Islamic investment management business called Asian Islamic Investment Management, with DBS Asset Management holding 51% and Hwang-DBS 49%. CIMB-Principal is owned 60-40 between Malaysia’s CIMB and US-based Principal Financial Group; CIMB-Principal Islamic Asset Management is wholly owned by CIMB-Principal. Reliance Asset Management is part of the Reliance Indian conglomerate.

These licences have since been followed by three more, for Aberdeen Islamic Asset Management, BNP Paribas Islamic Asset Management and Nomura Islamic Asset Management. All three already had a presence in the conventional asset management industry in Malaysia as part of a scheme in 2005 to broaden international participation in Malaysia’s capital markets.

All three are now building their businesses. BNP Paribas Investment partners, for example, has been running since February 2009 and is not yet managing assets (though it handles about half a billion dollars of Shariah-compliant assets globally). “Our licence doesn’t allow us to register funds in Malaysia, so we don’t do distribution here,” says Angelia Chin-Sharpe, executive director and country head for Malaysia and Brunei, and regional head for Islamic business development. “Instead we work with local institutions in Malaysia who intend to develop more global Islamic capabilities, and we provide them with the expertise to develop products.” This can be local fund managers with a mandate to develop their own funds with underlying global assets, or, increasingly, institutions who want their portfolios to be managed in a Shariah compliant way.

As discussed in the asset management chapter of this guide, institutional money is an increasingly powerful force in Malaysian Islamic asset management. “It boils down to the government push to position Malaysia as a global Islamic hub,” says Nor Rejina Abdul Rahim, managing director of Nomura Asset Management Malaysia. “The institutional funds that we focus on are mainly government-linked institutional funds. That’s where the mandates are coming from.”

For both groups, the incentives that came with MIFC made a lot of sense. “The most important things we have to commend the government of Malaysia and the regulators on are the regulatory, tax and accounting frameworks,” says Chin-Sharpe. “Not many countries that aspire to be Islamic platforms have done this. It is very important for institutions like ourselves to understand how to operate in a country like Malaysia.” Additionally, the newly licensed group qualifies for a 10-year tax exemption on revenues. “That is a good attraction.”

Nor Rejina agrees. “We are working closely with the MIFC initiatives and it makes a lot of sense,” she says. “When we started out our business in December 2006, one way of creating a niche for ourselves was to concentrate on Islamic asset management, and that’s what we’ve done. There was such a concerted effort by the government and regulators, with their incentives; trying to get a licence for us was not an issue, everything was very facilitative and we had no problems getting the business off to a very good start.”

It would be helpful, though, if these Malaysian institutions that are now willing to commission Shariah-compliant mandates would consider doing so in overseas markets. “We need Malaysian institutions to show an interest in diversifying their current portfolio, which is still very focused on the Malaysian capital markets,” says Chin-Sharpe. For example, one clear possibility for asset managers is the burgeoning takaful industry, which creates large volumes in premiums (or their Islamic equivalent) as in mainstream insurers that need to be invested. But so far it’s a domestic story. “At the moment local takaful and retakaful companies, which are under the purview of the central bank, have limitations in terms of investing assets offshore,” says Chin-Sharpe. “Most of their assets are managed in the domestic markets. But ultimately, as the business grows and they develop more international business, they will have to develop products that invest in global assets, or invest their proprietary funds internationally to diversify the risk. That could be an opportunity for us.”

Others are hoping to join. Prudential has been active in Malaysia for years, and has set up its own Islamic asset management business 100% owned by the Prudential group. It’s awaiting the final licensing approval from the Securities Commission, and hopes also to become eligible for the EPF mandate. “We are experiencing an increasing interest from government institutions or government-linked companies to request Shariah compliance in their mandates,” reports Zulkifli Ishak at Prudential Funds Management.

Naturally, Malaysia ultimately wants to see a quid pro quo through MIFC. In allowing foreign managers to come in, it hopes they will eventually bring money in from overseas to be managed in Malaysia too. At the time of the MIFC’s foundation the focus was very much on the Middle East, where investible assets have clearly been badly hit by the global financial crisis. But in the long run MIFC’s success will in part be judged on whether this works. It’s early days, but there are some good signs: Ishak says that as of July 31, Prudential managed RM400 million of funds sourced from overseas, or about 30% of total Shariah assets. Ishak says Prudential is developing an offshore equity fund through its Malaysian business.

The tweaks and liberalization continue. The financial liberalization package announced by Bank Negara in April was notably more generous to foreign Islamic banks than conventional: two new Islamic banking and two family takaful licences will be granted this year to foreign players, domestic Islamic banks can now have up to 70% foreign equity in them, and the same limit is now applied to takaful operators. Since then, the government has announced plans to allow five international law firms with expertise in international Islamic finance to practise in that field in Malaysia. The door is opening wider.

BOX: One bank’s experience.

Kuwait Finance House has been doing business in Malaysia since 1985, when it participated in real estate and other structured deals in the country, later branching into corporate finance for groups like Malaysia Airlines and Guthrie Group. It set up a leasing joint venture, KFH Ijarah, in 1985. But it took a significant step forward when it became one of three foreign businesses to be granted Islamic banking licences in 2005, as Kuwait Finance House (Malaysia) Berhad.

From the outset, the business was intended as “the launchpad for KFH in the Asia-Pacific region,” says deputy chief executive officer Ab Jabar Ab Rahman. Apart from financial solutions, “our mandate is to act as the intermediary and facilitator, to promote two-way investments and trade between Malaysia, Asia Pacific and the GCC countries,” he says.

KFH Malaysia started out with a focus on corporate and investment banking, and to a lesser extent commercial banking. KFH had built expertise in the Middle East in areas of financing that had not yet penetrated Malaysian Islamic institutions, such as aviation finance, aquamarine, healthcare, agriculture and construction, so it set out to build a niche there ahead of a phased roll-out of commercial, retail and consumer banking. Early on, it opened a US$600 million real estate fund to invest in properties in the region, of which the best known in Malaysia is the iconic Pavilion KL.

By 2007 the bank was ready to launch its retail and consumer banking arm, including a wealth management unit with priority banking. Today it has seven branches, from the Klang Valley to Penang, Johor Bahru and Sarawak. Regional expansion has followed too, with subsidiaries to the Malaysia business opening in Singapore and Australia. Alongside this, the group gained an asset management licence to handle Islamic fund management.

Like other foreign institutions, KFH feels well looked after. “We have received tremendous support from the Malaysian authorities, regulators and our customers, without which we would not have reached this far,” Ab Jabar says. “The country has a business friendly approach, political stability, a strong legal system and relatively low cost of doing business.”

It wasn’t without its challenges, though. “Being the first foreign Islamic bank to start operations, we have had to address a few hurdles, such as regulatory matters and tax issues,” he says. “Another challenge in the beginning was, being a foreign entity, we could not own property as required under some of our financing concepts. So, for our home financing, we needed approval from the Foreign Investment Committee.” These issues have since been resolved, he says.

Another challenge – a common comment among foreign and local institutions – was a scarcity of skilled human capital in the Islamic banking industry. KFH set out to hire from conventional banks or other industries, but “we found out that there was a lack of awareness of Islamic banking.” Educational briefings and an intensive training programme were launched.

Despite these headwinds, the business was profitable from the first year and has introduced some interesting Middle Eastern structures to Malaysia, notably the pure Musharakah, or joint venture. Ab Jabar is positive about the opportunity. He believes the Malaysia business, including its regional operations, can grow its asset management business “ten-fold”, and thinks this business will also “play an important role as the conduit for the Middle East investor to participate in the Asia Pacific growth story.” If that’s true, it will make it very popular with Malaysia’s authorities, who had exactly that in mind when they started letting foreigners set up in the first place. Ab Jabar also expects steady growth in corporate and investment banking, commercial banking, and retail and consumer; it intends to launch a Cashline revolving financing line for small to medium enterprises.

In terms of attracting those Middle Eastern assets, KFH has two Shariah-based funds designed to bring investors from the Gulf to Malaysia, apart from the early real estate one. Al Nibras 2 Fund, a Labuan-based offshore private company, spent US$330 million on a land concession at Medini Iskander Malaysia, one of the so-called cultural clusters at the vast Iskander development in southern Malaysia. This, says Ab Jabar, is “the single largest foreign real estate development in Malaysia.” Another fund, Al Faiz Fund 1, is a joint venture between KFH’s Malaysian asset management business and Al Aman KSCC, a Kuwait-based financial services group. It is a Shariah compliant buy-out private equity fund focusing on private enterprises in southeast Asia, India and China, and it is mainly made of institutional investors and high net worth individuals from Kuwait, Malaysia and Brunei.