Social development

IFR Asia - Asian Development Bank 2016
11 min read
Steve Garton

Malaysia has shown that sharia-compliant bonds provide a dependable source of funding despite a political crisis that has rocked international confidence.

Malaysia has been the driving force behind the development of an Islamic capital market in Asia. As much as 25% of all financing assets in the country’s banking system are now sharia-compliant, according to a 2015 review from consultancy EY, with 21% of total banking assets qualifying as Islamic.

A common determination on the part of the government, finance ministry and central bank has fostered the creation of a deep pool of long-term Islamic capital, in turn driving local demand for long-term assets such as infrastructure financing.

The local ringgit market has weathered a political storm in recent months, and recent issues in the global markets show that Malaysia has also broadened its links with international Islamic investors, especially in the Middle East.

Infrastructure-related trades, principally related to road construction, are heavily represented in the Malaysian pipeline. CIMB forecast last December that as much as M$75bn (US$19.3bn) of new Malaysian sukuk could print in 2016. Around M$34bn of Malaysian corporate sukuk is maturing this year, offering the possibility of a round of refinancing trades.

“Notwithstanding the uncertainties surrounding the general market outlook, we expect Malaysian sukuk issuance to sustain its momentum and to exceed last year’s tally in 2016 for a total of approximately M$65bn-$70bn in 2016.”

“Islamic finance is no longer a fad,” said Ashraf Mohammed, ADB’s assistant general counsel and Islamic finance practice leader. “The Islamic market can be a stable alternative because of its linkage with real assets.”

Efforts to connect sharia-compliant investors with infrastructure projects elsewhere, however, have proven more challenging. And even in Malaysia, growth is slowing. EY recorded a modest 0.6% market share gain for Islamic finance versus conventional banking in 2014, well below the 1.2% median for the previous four years.

This points to a maturing market that will need to innovate if it is to continue to expand.

“Islamic issuance from Malaysia slowed last year due to a combination of domestic economic weakness, the slowdown in China, a slumping oil price and uncertainty with regard to Federal Reserve rate tightening,” said Effendi Abdullah, head of Islamic markets at AmInvestment Bank in Kuala Lumpur.


Sharia-compliant issuance has been the mainstay of ringgit bond markets over the past decade, but issuance has declined in the face of the deteriorating credit outlook and weak onshore liquidity. According to data from Thomson Reuters, US$40bn-equivalent has been issued in conventional ringgit bonds over the past decade, versus US$130bn-equivalent issued in sharia-compliant paper.

The primary market has been on a downward trend: from a mammoth US$23bn-equivalent issued in 2011, issuance tailed off to US$13.8bn-equivalent last year. So far in 2016 US$1.9bn has been sold. Barring a forthcoming pick-up, this pace would take back the primary Islamic ringgit market to its paltry issuance of early in the last decade, when the average annual tally was US$7bn-equivalent.

Dragging down ringgit issuance in sukuk last year was the refusal of central bank Bank Negara Malaysia to issue short-term sukuk paper with less than three months’ maturity, citing the poor transmission of short-term sharia issuance to domestic liquidity.

Most of the paper BNM had issued in the previous few years was used by offshore central banks to manage their short-term liquidity. BNM’s withdrawal from short-tenor sukuk caused overall sharia issuance to contract by around US$10bn-equivalent last year, according to Standard & Poor’s. Still, the theory was that the corporate and government-linked sector would fill in the gap left by BNM’s retreat.

Credence was given to this view at the end of last year, when Malaysian corporates and state-owned enterprises rushed deals into the market, which in December raised a combined M$3.9bn in sukuk.

But a US dollar issue from state pension fund Khazanah in February again left a sour tone after a large slug of the US$750m paper was left on the underwriters’ books after pricing proved overly aggressive.

“There are repercussions for the ringgit market given the poor response to the Khazanah trade, because foreign investors hold around 30% of the Malaysian ringgit bond market and many of these investors also carry US dollar portfolios which diversify into Malaysian risk,” said a Hong Kong-based DCM head.

Weak oil prices have not helped matters, while the financial scandal surrounding government investment fund 1MDB has provided another unwelcome distraction for local dealmakers.

The 1MDB disarray, including accusations from the Swiss attorney general’s office that around US$4bn had been misappropriated from public finances and the heating up of investigations into 1MDB by law enforcement globally, including the FBI, Singapore and Hong Kong, may offer an explanation to any souring of investors’ appetite.

The script has been changing by the day, but the scandal that has engulfed Prime Minister Najib Razak refuses to go away.

Various unexpected twists have propelled the script, including the removal of many of Najib’s critics from office and the replacement of the country’s attorney general while Malaysia’s anti-corruption agency was investigating money flows from 1MDB.

The Parliamentary Public Accounts Committee in early April called for a probe into 1MDB and its former CEO Shahrol Azral Ibrahim Halmi, prompting the resignation of the fund’s entire board of directors.

The big rating agencies have all crimped Malaysia’s outlook in the last year, with Moody’s the last to act in January, moving it from a positive to a stable outlook on the basis of heavy capital outflows, a falling current account surplus, a declining ringgit and depleted central banks reserves.

The ringgit slumped almost 20% last year as the scandal festered and to blame Malaysia’s declining credit outlook solely on exogenous factors seems disingenuous. While the 50%-odd recovery in the oil price from its January 2016 lows will undoubtedly boost the net oil exporter’s public finances, the volatility of the 1MDB-Najib situation means Malaysia’s credit outlook is a tough call.

There is, however, cause for optimism. Despite the distractions, the ringgit bounced in February and a well-received M$3.5bn government bond auction, with a near three times bid-to-cover ratio, seemed to flag a turn in sentiment. And there is hope that the US$30–$35 oil price forecast built into Malaysia’s 2016 budget will allow the 4%–4.5% official GDP growth objective to be hit and brighten the credit outlook.

“Notwithstanding the uncertainties surrounding the general market outlook, we expect Malaysian sukuk issuance to sustain its momentum and to exceed last year’s tally in 2016 for a total of approximately M$65bn–$70bn in 2016,” said AmBank’s Effendi. “Domestic liquidity is strong and foreign investors are now looking at the Malaysian sukuk market with renewed interest thanks to more generous yields and a better outlook for the ringgit.”

“Add to this a solid refinancing pipeline together with an auspicious supply/demand dynamic and the market looks in decent shape. This was clearly demonstrated last month with sukuk issuance from Sime Darby which was almost two times oversubscribed.”

Sime Darby in March issued a M$2.2bn perpetual sukuk, callable after 10 years, at a yield of 5.65%. That marked the world’s biggest Islamic perpetual from the corporate sector, according to sole lead manager Maybank.


When it comes to multilateral efforts to promote Islamic finance, Malaysia is again leading the way. The International Islamic Liquidity Management Corporation, whose shareholders include Malaysia, Indonesia and the Islamic Development Bank, has issued around US$3bn of short-term sharia-compliant paper since 2013, helping resolve an asset-liability mismatch for Islamic banks. Based in Kuala Lumpur, it was championed by Zeti Akhtar Aziz, the outgoing head of Malaysia’s central bank.

“The infrastructure buildup there has been very impressive,” said Ashraf at the ADB. “It’s a good model.”

The ADB and other multilaterals believe they can act as a catalyst for further innovation by bringing the public and private sectors together.

The ADB completed its first Islamic financing in 2012, co-financing a wind project in Pakistan alongside the Islamic Development Bank, and is now working to close its first A/B project financing under Islamic documentation. The ADB is hoping to close two Islamic projects this year, the first of which will again be in South Asia.

Other multilaterals have gone further still. The World Bank has established a Centre of Excellence for Islamic finance in Turkey, and the International Finance Corporation has twice issued sukuk to support its lease financing operations, especially in the healthcare sector. The most recent issue, a US$100m five-year amortiser in 2015, priced at 10bp below Libor. IFC’s first Islamic financing was a leasing project in Pakistan in 1995.

The Islamic Corporation for the Development of the Private Sector, the Islamic Development Bank’s private sector arm, continues to forge alliances across Asia, most recently agreeing a feasibility study on a US$100m credit line from Export-Import Bank of India to support Indian exports to its member countries.

Global markets bankers say the slump in oil prices crimped investment from the Middle East in the early part of 2016, but that blip appeared to be short-lived. By the time Indonesia issued its US$2.5bn global sukuk in March, Gulf allocations were back in force.

Rather than a hurdle, the ADB’s Ashraf believes the oil price slide may be a catalyst for issuance.

“Governments need to consider innovative financings for their infrastructure projects,” he said. “They can finance their projects through Islamic finance to help fill the gap post the oil rout.”

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Social development