Malaysia & Islamic Finance

(click on image to read the Sukuk table)

• Moody's: Global sukuk volume up to 2007 reached US$97.3 billion, with corporates surpassing sovereign issuance as firms shift funding to debt markets after 2006 equity markets bust. 30-35% sukuk issuance growth expected in 2008
• EIU: scholarly objections unlikely to put the brakes on sukuk growth
  
• IMF:
  -Islamic Finance: Financial relationships using investments subject to the moral prohibition on (i) interest earnings & money lending, (ii) speculation & betting, (iii) financial derivative instruments & forward contracts
  -Yield pickup & diversification have attracted Hedge funds & institutional investors to Islamic securities
  -Issuance of Islamic securities (sukuk) rose fourfold during 2004-06 to US$27 billion, with Islamic banking growing 10-15% annually over the past decade
• AAOIFI: As many as 85% of Islamic bonds may breach Sharia law in some way
  
• Reuters: Current lack of consensus among religious scholars means financial institutions rely on in-house experts. Only Malaysia has centralized approval board.
• In part, explosion of Islamic bond market (worth US$68b or a 15-fold increase in past decade) an attempt to tap petrodollar wealth

Malaysian Experience by Dr. Zeti Akhtar Aziz
Allow me to take this opportunity to share with you Malaysia's experience in developing the Islamic financial system, and in particular, the Islamic capital market. Malaysia has developed over more than two decades, a comprehensive Islamic financial system that operates in parallel with the conventional financial system. The Islamic financial system in Malaysia has evolved as a competitive component of the domestic financial system with a significant number of diverse players in the Islamic banking, the takaful industry and the Islamic money and capital markets. Our approach has been to focus on institutional development, reinforced by a robust Shariah, legal and regulatory framework as well as the investment in human capital development. In this more recent decade, attention has been focussed on developing the financial markets, in particular the sukuk market, and on the liberalisation of the Islamic financial system. We are now entering a new phase in the development of Islamic financial system in Malaysia with initiatives to position Malaysia as International Islamic financial hub. The initiative is aimed at strengthening our international economic and financial inter-linkages and thus promoting greater regional and international trade and investment activities. As part of the wide ranging liberalisation measures, we have seen the entrance of new foreign Islamic financial groups into our financial system. New licences have been issued and greater foreign interest in the domestic Islamic financial institutions have also been permitted. In addition, the listing rules were liberalised to facilitate foreign and cross-border listings. New licences are also being issued for International Islamic Bank and International Takaful Operator to conduct Islamic banking and takaful and retakaful business in international currencies. The most significant progress that has been achieved is in the development of the Malaysian sukuk or Islamic bond market. The Malaysian sukuk market is now the largest Islamic bond market in the world with more than 62% (or USD60 billion) of the global outstanding sukuk having been originated from Malaysia . Supported by a comprehensive infrastructure including the settlement and bond information system, Malaysia has an active primary sukuk market with an average annual growth of 17% over the period 2001-2006. It also has one of the most active secondary markets with a turnover of sukuk trading registering of more than USD40 billion annually. The Malaysian bond market has also been liberalised to enable foreign entities to raise ringgit and foreign currency denominated funds from our market. International issuers may thus issue multi-currency Sukuks or alternatively have the flexibility to swap domestic currency funding into other currencies. At this juncture, I'm also pleased to inform you that a Malaysian corporation recently issued the largest-ever sukuk issue in the world amounting to equivalent USD4.7 billion which was two times oversubscribed. This hybrid sukuk which has both equity and debt natures is one of the several innovative instruments that has been issued in the sukuk market. Malaysia 's development of Islamic finance has contributed positively to our overall financial system in several respects. This has resulted to a more diversified financial system that has increased its overall resilience. Secondly, it has increased our international linkages. Thirdly, it has also contributed to greater financial inclusion particularly in the area of financing for small and medium scale enterprises and micro financing. Then, enhanced with the in-built checks and balances, it contributes towards financial stability. Finally, Islamic finance has become a new area of growth that has become very vibrant in generating income, wealth and employment.

Opportunities in Sukuk

In the current liberalised and globalised environment, Islamic finance is now at the threshold of a new dimension in strengthening financial inter-linkages between nations in the global economy. With the expanded scope of activities in Islamic finance, the Islamic bond market or Sukuk market has fast become an important avenue for fund raising and investment activities . The Sukuk market has registered a remarkable growth, increasing at an average annual rate of 40 percent with a current size of more than USD82 billion. The vast potential in Sukuk market in the international financial system indeed represents the crest of a new wave of innovation in Islamic finance. This is evidenced by the active participation of a great number of global players such as investment banks, Islamic banks and securities firms in the issuance of Sukuk. The Sukuk market brings with it great benefits to both issuer and investors. For issuers that include government agencies, multinational corporations and multinational development institutions, Sukuk plays a multi-faceted role in meeting different funding requirements ranging from large infrastructure and developmental projects to capital and business expansion. This is particularly important for emerging market economies. The Middle East and Asia currently represent the two fastest growing regions in the global economy. These regions are aggressive in their privatisation efforts and in the implementation of infrastructure and developmental projects. Asia alone will be spending an estimated USD1 trillion on infrastructure over the next five years, while infrastructure requirements in the Middle East are estimated to be USD700 billion over the same period³. While in Malaysia, the National Economic Regional Corridor plan requires an estimated USD192 billion (RM620 billion) of investment.⁴ On the demand side, the issuer also benefits from the competitively attractive pricing of Sukuk ranging from 10 to 20 basis points lower than mainstream bonds. This has resulted from the continuous over subscription of the sukuk which has ranged from two to thirteen times. The phenomenal demand for sukuk is further reinforced by excess liquidity in the global financial system. This demand comes from a relatively wider investor base that comprises both the conventional and Islamic investors. The strong demand for sukuk has also been spurred by the higher level of surplus savings and reserves in Asia . In the case of Japan , apart from the high savings rate, Japan has the largest percentage of high net worth individuals wealth distribution in the Asia Pacific. From the investors' perspective, besides the intrinsic value of sukuk which is largely asset-backed , convertible to shares and exchangeable with shares, there are benefits of diversification . Sukuk is fast becoming a new asset class . Sukuk has also generated good investment returns for investors arising from its higher pricing in the secondary market due to the "buy and hold" preference and its scarcity.

Opportunities in Takaful

The other opportunities in Islamic finance are in the takaful or Islamic insurance and re-takaful. The global takaful market, in particular, has also undergone positive developments at the international level. From only a single takaful company being in existence more than twenty years ago in Sudan, the takaful industry has now expanded with the establishment of more than 50 takaful companies worldwide with a total contribution estimated at about USD3 billion for the year 2005. The takaful industry is expected to grow at about 20% per annum to reach USD7.4 billion in global annual contributions over the next ten years ⁵. It is also encouraging to note that the number of retakaful companies have also grown in tandem with the increased number of takaful companies ⁶. The need for strong and credible retakaful operators globally is important to complement the growth and expansion of the takaful industry. Let me turn to Japan's potential participation in Islamic finance. We welcome the participation of Japanese financial institutions, authorities and corporations in Islamic finance, particularly, in the Islamic capital markets. Japan thus far has for several decades had a significant economic role in the Asian region in terms of trade and investment. Japan 's investment in the region is estimated to be USD45 billion over the period of 2004-2006⁷. Japan has also been consistently ranked among the top five investing nations in Malaysia , with investment flows amounting to 25.7% of the total flows for the period of 2000 to 2006. In 2006 alone, Japan foreign direct investment inflow into Malaysia was at USD6.1 billion⁸. Japan has also remained a significant partner in trade with Malaysia. While Japan 's economic relationship in investment and trade in the region is well established, there is a significant potential for strengthening further the financial linkages in future. There is potential to evolve the direct investment and trade in goods to grow the financial ties. Islamic finance represents a vehicle that could further deepen our financial relationship and the regional financial integration process. By enhancing new linkages in this relationship and the prospect for greater integration, it would contribute towards unlocking potential opportunities for mutual prosperity of the region. To advance relations in the area of Islamic finance, a memorandum of understanding between the Central Bank of Malaysia and Japan Bank for International Corporation (JBIC) was signed in 2007. There is also a strategic alliance between one of the world largest Japanese insurance groups with a domestic insurance company in Malaysia which resulted in the establishment of a takaful company. Efforts can also be focussed on facilitating cross listing of sukuk in multiple jurisdictions. Japan may also use Malaysia as a platform for innovation and research in Islamic finance. There are various institutions, including the industry-owned research and training institute in Islamic finance, the Islamic Banking and Finance Institute Malaysia (IBFIM), INCEIF and universities which have undertaken research on Islamic finance. Thus, it is hoped that the Japanese participation in the Islamic financial markets would contribute towards further international financial integration and thus achieve a more efficient allocation of resources across borders.