Malaysia - a natural destination
When Thailand and South Korea were planning to test investor appetite for their respective debut offshore Islamic bonds, the first country they included at the top of their destinations was Malaysia. By Boey Kit Yin.
That choice surprised no one. Malaysia has dominated the global sukuk market, accounting for the bulk of sukuk issues in the world. According to a Standard & Poor's report, Malaysia accounted for about 45% of all sukuk issues, totalling US$9.3bn, in the first seven months of 2009. Although this was a 16% drop from the US$11.1bn sold in the corresponding period in 2008, the top market was still in Malaysia. Saudi Arabia was a distant second, accounting for 22% of total issuance.
Islamic finance runs in the blood of the capital markets in Malaysia. It has taken such a dominance in the industry that it has become mainstream. Taking a look at the statistics will explain why. About 88% of the securities listed on the Bursa Malaysia were Sharia-compliant as at May 2009, accounting for 64% of the total market capitalisation.
Also, by June 2009, more than half – or specifically 58.2% – of outstanding bond issues were Islamic. That amounted to M$167.8bn (US$48.2bn) worth of outstanding sukuk in Malaysia. Worldwide, Malaysia accounts for 57% of outstanding global sukuk.
Malaysia has come a long way since it launched the first sukuk in 1990. That issue was not for a domestic company but, ironically, for multinational Shell, and one person involved in that deal has since become the chairman of the Securities Commission – Zarinah Anwar. That experience is one of the key factors that explains why the SC puts its full weight behind a 10-year capital markets masterplan that aims to strengthen Malaysia's role as an Islamic hub in the world.
Speaking at an event in London in July this year, Anwar said that in that 1990 deal, the structuring team faced a daunting task of dealing with unchartered territory. The Shell sukuk issue "was a milestone in many respects: it was the first sukuk to be issued in ringgit; it was the first ringgit sukuk to be issued by a multinational company; and, importantly, it jump-started the Malaysian Islamic capital market".
Islamic finance had arrived in the realm of the capital markets, allowing more efficient balance-sheet risk management, diversification of investments, a lowering of funding costs and property capital adequacy maintenance through financial practices that comply with Sharia principles. "As a result, what we have today is truly Islamic finance, in the broadest sense of the word," said Anwar.
The rapid rise in the Islamic bond market in the past few years is a one major reason why there is a sudden awakening around the world to the potential of raising funds in the sukuk market. In its statement on Islamic bonds on September 29, South Korea's Ministry of Strategy and Finance pointed to the rise of the global Islamic bond market as the reason for its keen interest in tapping that market. Sukuk issuance was only US$0.3bn in 2000. Two years later, that number had risen to US$1bn, and then it grew to US$7.6bn in 2006 and it has taken off from there. By 2007, the number of global bonds sold as sukuk had hit a record US$31bn.
In Asia, South Korea is the latest country that has joined a growing list hoping to build up an Islamic finance industry. But, unlike others, it does not appear to have any interest in becoming a regional Islamic financial centre. Instead, it plans to introduce a tax-friendly environment for its corporate borrowers to diversify external funding sources – an important goal for a country where borrowers are always hungry for funds.
It is Indonesia that presents the biggest challenge to Malaysia in terms of becoming an Islamic finance centre in Asia. Both its debuts in the local currency and global bond markets, in 2008 and 2009 respectively, were hugely successful and the government has since followed that up with more sales of rupiah-denominated bonds. The government has been experimenting in selling sukuk in varied structures – reflecting an aggressive approach that could help it catch up with Malaysia's entrenched Islamic sukuk market.
The success of selling sukuk to plug a huge budget deficit this year is pushing the Indonesian government to explore other avenues, and one of the more exciting ones is in the area of project finance. Although Malaysian corporates have a long history of raising infrastructure funds through the sukuk market, Indonesian projects are entirely reliant on the banking loan market. Tapping a new avenue in the sukuk market would provide Indonesian projects with a competitive source of funds.
But it takes more than just government-backed sukuk to build an Islamic financial centre. Indonesia could look across the straits to emulate the Malaysian model. What Malaysia has is an established integrated financial industry that has been built around Sharia-compliant principles.
"It is not just having tax laws to facilitate sukuk or just government sukuk to set the benchmarks and the yield curves," said one Malaysian banker. "It is also about the Islamic fund management base, the insurance base, the derivatives and the exchanges, and the necessary training and education to provide the skilled base to handle Islamic finance."
A critical factor behind Malaysia's successful Islamic markets has been the role of the regulators. KFH Research Ltd's managing director and vice-chairman Baljeet Kaur Grewal said in a recent report that the Malaysian blueprint facilitated an efficient issuance process, "creating a price discovery process, broadening the investor base, establishing a benchmark yield curve, invigorating liquidity in the secondary market and strengthening the regulatory framework". Such a system is supported by a comprehensive legal and Sharia framework.
Market observers say the government, central bank, SC and Bursa Malaysia have worked together to create a systematic and integrated framework of laws, rules and guidelines to support the development of Islamic finance. On top of this, the Sharia Advisory Council exists to approve principles for different products and services.
The lack of fear in introducing new and innovative products has been a hallmark in the Malaysian corridors. In 2006, the first Islamic REIT was introduced in the country when Al-Aqar KPJ REIT was launched by KPJ Healthcare. Two more Islamic REITs followed, including the first plantation REIT in Al-Hadharah Boustead REIT. This has encouraged Qatar-based Ezdan to examine if it could set up an Islamic REIT in Malaysia.
In 2007, dominant telco Telekom Malaysia tied up the world's first exchange offer of M$3bn Sharia-compliant stapled income securities through Citigroup, and in 2008 it was back with a M$1bn torch-bearing deal of property-backed Islamic securities that was the first off-balance sheet property-backed deal to comply with Sharia law.
Malaysia continuously introduces innovative elements to broaden and deepen the Islamic finance markets. In one of the most recent developments, Petronas and Cagamas listed their sukuk on the exchange – the first time sukuk had been listed there. Petronas sold US$4.5bn of five-year and 10-year global bonds in August, all of which were listed on the Bursa in August. Of these, US$1.5bn are in a five-year sukuk that is the largest Islamic global bond issue, equalling Dubai Ports' 2007 deal.
National mortgage agency Cagamas – one of the biggest domestic issuers in the country – has also listed all its outstanding sukuk and bonds under its five residential mortgage-backed securitisation issues, amounting to M$4bn.
The idea behind the listing was to raise trading and pricing transparency for investors, especially in the wake of high-profile defaults on a couple of Middle Eastern sukuk.
Other introductions made by the government in the Islamic finance space included the launch of Bursa Su Al-Sila, the world's first Sharia-based commodity trading platform, the development of Sharia-compliant Islamic stock lending process as well as the expansion of hedging tools to ensure that the underlying asset and derivative contracts comply with Islamic principles.
Looking to the future, Malaysia is hot-footing it around the world to woo foreign issuers to the ringgit market to sell sukuk issues. At the same time, its leading Islamic banks – including CIMB, Maybank and AmInvestment Bank – are courting regional issuers for global roles in international issues. CIMB grabbed a piece of action when it was one of the leads named in the Petronas global deal.
The country has met some success in the first goal. Tesco became one of the first few foreign-based issuers to sell a hugely successful M$700m five-year sukuk issue in Malaysia in 2007, while Toyota Motors solidified the ringgit Islamic bond hub with a M$1bn guaranteed musharaka MTN programme for UMW Toyota Capital in 2008.
Last year finally saw a Gulf borrower tapping the Malaysian sukuk market. Islamic Development Bank set a benchmark for Gulf issuers in Malaysia after it tied up a debut M$300m five-year sukuk issue. That deal underscored a gradual – albeit slow – acceptance by Gulf borrowers of Malaysian Sharia standards – a subject that has split Middle East Islamic and Malaysian markets.
Malaysian Sharia standards have always been perceived as too liberal in the ME. IsDB has since followed that up with a small S$200m (US$141m) three-year sukuk deal in Singapore in September this year.
Malaysia's credentials as a sukuk hub will be enhanced further when the Thailand and South Korea governments make their debut Islamic bond issues in the ringgit market. Thailand's government is planning to sell a small maiden issue in Malaysia through its government-owned Islamic Bank of Thailand to test the appetite for Thai paper. The South Korean government is planning roadshows in Kuala Lumpur and the UAE to introduce a new tax regime for South Korean sukuk, with an intention to issue Islamic bonds in both markets.