MALAYSIAN ISLAMIC FINANCE Issuers and Investors Forum 2006

Routes to the Islamic bond market

Having introduced Aseambankers’ Baljeet Kaur Grewal as the “guru” of Islamic bonds, moderator Abdulkader Thomas started the ball rolling by posing a question to Baljeet – what were the strengths and challenges in the Islamic bond market, particularly in Malaysia?

Baljeet noted that having successfully managed the Asian financial crisis in 1997, a far more exciting phenomena was the development of the Islamic capital market, which grew in tandem with, and parallel to, its conventional counterpart. Success factors included robust primary issuers, largely spearheaded by government sectors like the Central Bank. She said the numerous primary sovereign issues in the market had given an added impact to the resilient pricing mechanism, spurring the Islamic capital market forward.

Baljeet also highlighted the role of regulators in acting as a catalyst to the growth of the market, with tax incentives, a Shariah framework, as well as new product guidelines. Interestingly, she said the composition of the market players – namely government, quasi-government, supranational and multinational – as well as the issuance composition – ranging from infrastructure, plantation, equity, to financial services – also contributed to the compounded annual growth of 28.3% in the Islamic bond market for the past 10 years.

Abdulkader added that another important issue enabling the growth of the Islamic capital market was the capacity to rate and thus to tell accurately the potential risk underlining the issue. He asked Liza Mohd Noor of Rating Agency of Malaysia (RAM) what the requirements were for prospective issuers to better understand the benefits of rating.

Liza explained that a rating exercise was basically to inform investors of the risk level that would facilitate the pricing mechanism, and as it is mandatory for all bond issues in Malaysia to be rated, it was then easier for the rating agency to have access to information, thus enabling it to conduct a continuous surveillance process. Liza stressed that credit rating agencies had to act in a timely manner to ensure that a credit rating remained accurate. A rating report, she added, would give investors an expectation of the capital preservation, as well as the expected return, as indicated in the term sheet.

In discussing the skills set that would help the growth of the Malaysian Islamic bond market, Mohd Effendi Abdullah of AmInvestment Group said that issuers had to be more innovative and think ‘outside of the box’. “Islamic bonds are very versatile in terms of their underlying structures and embedded conditions, as compared to the conventional debt-based bonds,” he stressed. Supporting Effendi’s stance that issuers should look to the bigger picture when developing Islamic bonds, Jean-Marc Riegel of Qatar Islamic Bank added that bonds should be structured in such a way that they would be accepted and used in other parts of the world, especially in the GCC.

The second part of the session continued by looking at the challenges faced in the development of the Islamic bond market. Baljeet listed some of these challenges: maintaining sustainable investment; building a critical mass of institutions and products where technology is infused in the Islamic finance sphere; increasing secondary market liquidity; and encouraging increasing efforts in research and development. However, Effendi pointed out that a challenge was not so much the number of issues, but the necessity for the underlying structure of the bond to address financial needs.

Dividing challenges between the arrangers and the issuers of bonds, Liza commented that the arranger would be challenged on innovative structures, while the issuer would aim for the highest rating possible. However, the oversubscriptions of most Islamic bond issuances indicated that local players were capable of meeting those challenges.

Jean-Marc, speaking from the perspective of foreign players, highlighted the underwriting capacity of local players, and also the currency swap or hedging mechanism that was still not in place, as some of challenges currently faced.

Baljeet explained that most players were ready with currency swap mechanisms; however, as most of the debts raised were for Malaysian projects, the need for such mechanisms was not currently pressing. Bank Negara Malaysia was actively setting up a committee to look into currency swap, as the next stage in the evolution of Islamic finance.

In terms of ringgit stability, Liza said players had been much wiser in their funding, especially in the matching of assets against liabilities, after the Asian financial crisis. While observing the danger signs, with the gearing of some economic sectors up to four times their assets value, she noted that the ringgit was still considered stable from a credit rating standpoint.

Wrapping up the whole session, the panel speakers concluded that Malaysia had almost a complete package, with a stable financial infrastructure, a robust private sector and more importantly a very supportive government.