China report – capital markets

China’s stock markets are back with a vengeance. The Shanghai Composite Index, the worst performing major market last year, has doubled since November, better than any comparable index worldwide. The initial public offering of China State Construction Engineering, which raised RMB50.2 billion in July, was the biggest in the world since March 2008. And new IPOs are in some cases trebling on debut. Which raises the question: boom or bubble?

The pace with which China’s markets have rebounded has been extraordinary, but in keeping with the behavior of one of the world’s most volatile markets. Despite the fact that China has weathered the global downturn surely better than any other major nation – many believe it is on track for 8% GDP growth in 2009 – its stock market dropped 65% in value in 2008 before this year’s rebound. By market capitalization China is now the second largest stock market in the world, overtaking Japan, but this scale has not given it stability, and the dominance of retail money has made it a particularly fiery place to be. That’s not going to change any time soon: in a single week in July, 566,937 new trading accounts were opened.

A bubble? If so, not yet, according to fund managers. Samantha Ho, investment director at Invesco and manager of many of its Greater China products, notes that the MSCI China index is trading on a price earnings multiple of about 17 times, about midway between historic lows of 10 and highs of 25 times; and that the A-share market (domestic shares which can generally be purchased only by people within China) is trading at 26 times, again in the middle of its recent range. “We’re definitely not cheap, but we’re not expensive either; we may be looking at fair valuation,” she says. “If you believe, as I do, there will be earnings growth this year, the market is not that expensive.”

There are several kinds of Chinese stocks. A-shares tend to have a higher valuation because local investors have very few investment vehicles to choose from given the capital controls that restrict most Chinese from investing outside China. That creates high demand for local stocks. Most international investors get exposure to China through H-shares, which are Chinese companies listed in Hong Kong, or red chips, which are domiciled outside China but get almost all of the revenues from China and are typically owned from the mainland.

Most of the stock market gain took place during a period in which domestic IPOs were suspended. They stayed that way for nine months until the end of June, creating pent up demand which has been reflected in some remarkable listing stories.

After two smaller issues, the first listing of note after the end of the ban was the IPO of Sichuan Expressway in Shanghai. On its first day of trading it tripled in value at one stage. Hong Kong is experiencing similar fervor for Chinese stocks (see box).

“The IPO pipeline has been building up for the better part of 18 months,” says Chris Keogh, senior advisor to the chairman at Gao Hua Securities, the Beijing partner of Goldman Sachs. Keogh says he is not concerned about the size or pipeline of the IPO market. “Yesterday [July 29] the market turned over US$60 billion – that’s more than all the other markets in the world combined,” he says. “The ability for these IPOs to come to market is certainly there. The only thing I really worry about is how much of this market is still dominated on a daily basis by retail investors. It’s about 80 to 85% and that leads to excessive intra-day volatility: as fast as the market has gone up, it can absolutely go down.”

While domestic stock markets capture the headlines, the development of the local bond market is just as significant – and is growing fast.  “You’ve seen tremendous growth in all segments of the RMB bond market in China: enterprise bonds, CP [commercial paper] and MTN [medium-term note],” says Patrick Tsang, head of cross border debt capital markets at Deutsche Bank. “A couple of years back there was much growth on the equity market side, but in the last two to three years you’ve seen similar momentum in the debt markets.”

In absolute terms, bond issuance may be a lower total for 2009 than 2008, but this misses the more interesting fact, argues John Sun, executive director, fixed income for Citic Securities International. “The reason the overall number in 2009 is because there have been less treasury securities as the central bank doesn’t want to withdraw liquidity from the market,” he says. “But if you look at corporate bonds, in 2008 only about RMB85 billion was issued; in 2009 we expect it’s going to reach 500 billion, six or seven times higher.”

2008 saw the launch of a whole new type of bond, the medium term note (sometimes referred to locally as a mid-term note). The significance of this market rests with the regulators who oversee it. China’s bond markets are overseen by a labyrinthine range of regulators. The National Development and Reform Commission regulates the corporate bond market for unlisted companies; the China Securities Regulatory Commission regulates the corporate bond market for listed companies and oversees the underwriters. The People’s Bank of China regulates the structure of the industry, banks, and interest rates. The Ministry of Finance has an involvement, such as for supranational issues. And then the new MTN market is regulated by a different group altogether – a self-regulatory body, the National Association of Financial Markets Institutional Investors (NAFMII).

“My view is this new entity [MTN market] will become a much more popular method of issuing bonds in future,” says Sun. “The regulator is an association, and the application procedure is much simpler compared with other routes.” Also, Sun says, it doesn’t have the short-term limitations that the term MTN infers in international markets: issues can go as long as 10 years in tenor, although so far they have tended to stop at five.

There is, though, a sense of whether the domestic bond market could be more than it is. “On the demand side, institutional investors in China are absolutely dying for longer duration, higher yielding debt investments, which suggests seven to 10 year maturity and corporate credit,” says Keogh. Insurers, for example, are obvious buyers: they have lots of excess RMB capital to invest, and they need long-dated instruments to match the length of their policies. “But this demand is unsatiated even with the increase in issuance, because the increase has been in CP or the new MTN market – the shorter end of the curve.”

An interesting question is whether a panda bond market could be developed in China. This term refers to non-Chinese issues launching bonds in renminbi, onshore in China. This has two obvious attractions: it provides another source of funding to foreign issuers at a time when credit markets remain shut or at least difficult for many of them; and it provides a home for the vast liquidity in China’s domestic markets.

The idea of the panda bond market was first attempted in 2005 when two multilaterals, International Finance Corporation and the Asian Development Bank, issued them, on the strict understanding that the proceeds remained in China for development purposes. Much has been discussed since then but the idea didn’t really progress until July 2008 when China published a draft revision expanding the scope of panda bonds from development institutions to foreign banks and corporations with operations in China.

Standard Chartered is likely to be the first such issuer, although even then it will be through an entity that is incorporated in China, so one could argue it is not strictly speaking a panda bond. Other groups, notably HSBC and Bank of East Asia, plan to tap a different market again – issuing RMB denominated bonds in Hong Kong, a method which sources the significant retail deposits held in Hong Kong.

There’s no shortage of willing borrowers. “You would find issuers from General Motors to Walmart to any of a number of multinationals with liabilities or sourcing requirements in renminbi, who would want to issue tranches in renminbi as they already do in yen or euros,” says Keogh.

For sovereigns, too, there is potential, and this could benefit China itself. “We now have over US$2 trillion in foreign reserves, and about 70% of it is US bonds or assets,” says Yifan Hu, chief economist at Citic Securities International. This creates a clear exposure risk, particularly if one fears for the future performance of the US dollar. “The panda bond could be a short term solution. The US has to issue government bonds to support its economy; it could issue panda bonds to raise RMB, then buy US dollars from the central bank. In this way China continues to increase the US debt, and avoids the exchange risk.” In her view, “The Chinese will be more interested than the Americans, because the US would have more risk than China.”

Whatever form it takes, the debt markets have a big future in China, and one can already see international investment banks trying to take part in underwriting them – first Goldman Sachs and UBS through their pioneer ventures (see banking article), and more recently with the licenses granted to local joint ventures involving Credit Suisse and Deutsche. “It makes sense that China should have a vibrant RMB domestic debt market, and the government has taken the right steps in developing that market,” says Tsang at Deutsche. “I believe this will be an area of focus for us and other investment banks.”

THE ROLE OF HONG KONG

In recent years there has been a trend for China to encourage its companies to list on the A-share markets of Shanghai and Shenzhen, rather than just following the pattern of previous years and trekking to Hong Kong.

This raised doubts about Hong Kong’s continuing viability as a listing venue for Chinese companies. But recent weeks suggest there’s not much to worry about yet. At the end of April, China Zhongwang raised US$1.27billion in a Hong Kong IPO, in what remains the second largest IPO globally in 2009 at the time of writing; when Beijing-based building materials manufacturer BBMG came to the markets in July, raising US$884 million, its retail tranche was oversubscribed 800 times and its institutional side 200 times. “That’s something we haven’t seen since 2007,” says Kester Ng, head of equity capital and derivatives markets at JP Morgan.

While China’s stock markets may threaten Hong Kong in the long run, for the moment they are very different. “China is a closed market,” says Ng. “Unlike New York or London where money flows in and out and an investor in Hong Kong can buy shares in New York or vice versa, in China you cannot buy Chinese shares from overseas unless you have a quota.”

 “I don’t currently think about a Hong Kong versus Shanghai discussion,” says Ng. “They cater for very different investors. Until that investor base converges, it’s not Hong Kong versus Shanghai.”

A growing number of banks and states in Australia who have access to the government guarantee on their funding are opting not to use it.

Why? It’s really to make sure that issuers don’t lose touch with an investor base that has supported them over the long term, and who they will need to tap again when debt markets eventually regain their shape.

“There is demand from credit buyers who would prefer to invest in the credit rather than the guarantee, so it is important for us to ensure that those investors continue to be informed on our credit and have access to our non-guaranteed paper,” says John te Wechel, general manager of group funding at Commonwealth Bank of Australia.

CBA is a good example of this approach: it was the first Australian big four bank to issue without a guarantee, and so far has raised about A$6 billion in this way since the guarantee was first made available in November. While that’s much smaller than the A$26 billion it has raised with the guarantee in that time, it’s still a significant volume of funds.

Its landmark issue came in February, where it raised A$2.75 billion through a three-tranche self-led deal, within which one of the tranches, a three-year floating rate note bond worth A$250 million, did not carry a guarantee. (Strictly speaking, the first guarantee-eligible institution to launch a bond without one was Rabobank Australia a week earlier, with a A$800 million bond via Commonwealth Bank of Australia and Westpac, but it was the appearance of a Big Four domestic bank that really caught the eye.)

In early July, it took both approaches in the same week, raising A$3.3 billion in two issues. One was a self-led A$2 billion five year, with no guarantee; the other was a US$1 billion private placement of a four-year Regulation S/Rule 144a senior deal, with a guarantee, and led by CBA with Barclays Capital and Morgan Stanley.

CBA has been followed by other banks. National Australia launched an A$1.5 billion self-led three-year senior deal on April 29 without the guarantee. Other banks, and some Australian states, have also opted to issue without a guarantee when they could have opted to use one.

Clearly, a big issue to be considered here is price. Unguaranteed paper obviously prices wider than guaranteed, but issuers have to pay a fee to access the guarantee – in the case of double A rated banks, 70 basis points. When CBA did its February issue, this came out pretty much square: its unguaranteed tranche priced at swaps plus 130 basis points, while a guaranteed issue of A$500 million floating rate notes priced at 70 basis points over swaps, with the fee for the guarantee to be added.

These price differentials move around, making timing key. “The cost has to be comparable with where we issue with the guarantee, together with the guarantee price,” says te Wechel. “The spreads on guaranteed transactions have tightened in quite dramatically, as they have in non-guaranteed markets, although not necessarily to the same extent.” Te Wechel says, depending on the market, that difference can be as wide as 50 basis points or more, even allowing for the cost of the guarantee.

Te Wechel says that the tightening of spreads on guaranteed products shows that “investors seem to be taking the view it will become a scarce product, and we will be happy to issue into that demand as it arises.” He expects to continue to do both guaranteed and non-guaranteed funding through this year.

Banks have also started issuing into overseas markets without a guarantee. CBA was again the first here, but in somewhat obscure style, issuing in Thai baht at the end of May. While not a deep market, it has offered attractive cost of funds and a new investor base, and CBA will not be the last Australian bank to go there: ANZ too has approval.

In more mainstream markets, National Australia Bank has been more of a trailblazer, issuing in sterling and, most recently, in euros with a Eu1 billion seven year deal launched on July 9 via NAB, Deutsche Bank and UBS.

It’s not clear how long the guarantee is going to remain in place. “It’s difficult to know,” says te Wechel. “Some of the governments around the world have put a finite date on their guarantees, but a globally coordinated approach of moving away from guarantees would seem preferable.

“Until regulators and governments can be assured that banks will be able to meet their funding needs without the benefit of a guarantee, it seems premature to be thinking about removing them just yet.”

The panda bond is a great idea with a problem: it’s all talk, no execution.

From an issuer’s perspective, the appeal is immense. China has vast liquidity looking for a home; borrowers find themselves starved of opportunities in most of the world’s traditional bond markets as investors there remain risk averse or short of cash. Putting the two together, with foreign issuers raising funds in renminbi on the mainland, seems a great idea, but it just won’t gain any traction.

Will it in future? There have been many steps in the right direction. When first suggested in 2005, panda bonds were intended as a tool for multilaterals: International Finance Corporation launched bonds in 2005 and 2006, and the Asian Development Bank in 2005. This was on the understanding that the proceeds remained in China for development purposes.

 In July 2008, China published a draft revision expanding the scope of Panda bonds from these development institutions to foreign banks and corporations with operations in China. Specifically, the issuing bank’s Chinese domestically incorporate branches had to have three years of profitability before being permitted to issue bonds. (It appears this means all domestically incorporated branches, rather than the first one to be opened by a bank; this is a key point and makes a big difference.)

 Part of the challenge is the sheer range of groups that need to be in agreement before a bond can get away. Even for the multilaterals, “it does require several regulators to work together towards that goal,” says Rita Chan, an executive director at Goldman Sachs. “Subsequently, with individual corporates, there are much more detailed issues to consider: what accounting principle they should use, what ratings they should use, can they use international ratings – a lot of technical details still need to be finalized among the regulators.”

 Specifically, the National Development and Reform Commission regulates the corporate bond market for unlisted companies; the People’s Bank of China regulates the structure – interest rates, and so on; the Ministry of Finance was involved in the supranational issues; the China Securities Regulatory Commission regulates the corporate bond market for listed companies and oversees the underwriters; and the National Association of Financial Market Institutional Investors regulates the commercial paper and MTN markets. If a listed company from overseas issues a bond, there are further questions about the authorities that govern that company. On top of that, if the issuer then wants to take funds offshore again, then the State Administration for Foreign Exchange gets involved too.

 At the heart of it is that China has to consider why it would want to let foreign issuers – and especially foreign sovereigns, a logical next step – into this market anyway. “The Chinese government has been careful in terms of making sure the development of the panda bond market doesn’t impact its foreign exchange policies,” says Patrick Tsang, head of cross border debt capital markets at Deutsche Bank. “But from an issuer perspective, we’ve definitely seen a lot of inquiry – from supranationals, to banks, to corporates who have business in China.”

 Still, even if it’s slow, the direction is clear. “There’s a lot of interest from international issuers who would like to be able to access the China domestic bond market,” says Ronan McCullough, an executive director at Goldman Sachs. “As bond markets in China continue to move towards something that feels like an international model, there’s definitely going to be room in investor portfolios for this type of credit.

 “And this will tie in with other initiatives we’re seeing: international banks looking to access the domestic bond market business; Hong Kong and Chinese banks trying to access the RMB market in Hong Kong. All these things are different strands that will lead to a situation where the market is sufficiently developed, mature and diverse to be really viable in an international context when the market is opened up to external investors.”

 So who’s first? Standard Chartered has confirmed it is working on issuing RMB bonds in China – making them the first locally incorporated foreign bank to do so. In June, Stanchart said it was targeting a RMB3.5 billion issue. HSBC and Mizuho have also expressed an interest in launching these bonds in China.

 Separately, HSBC and Bank of East Asia both have approval to launch RMB bond deals in Hong Kong – an interesting separate development. The legal framework for launching these bonds in Hong Kong has been in place since 2007, and mainland banks including Export-Import Bank of China, China Development Bank, Bank of Communications and Bank of China have already taken this route, although HSBC and Bank of East Asia would be the first foreigners to do so.

 This market has a slightly different rationale. “Hong Kong is clearly a market which has a very limited pool of investors from which to draw,” says McCullough. “It’s effectively retail deposits in Hong Kong – there isn’t any pool of institutional renminbi liquidity in Hong Kong. It’s been a useful alternative for investors who would otherwise be putting their renminbi on deposit at close to zero per cent in the bank.” While that’s obviously a limited market, the recent steps to allow RMB settlement in Hong Kong have the potential to give it a fillip. From the issuer perspective, foreign banks do need to raise funds in renminbi to fund their capacity to grow on the mainland.

 One other interesting development is Chinese corporate issuing onshore in China, in dollars, as China National Petroleum (CNPC) did in May. This raises another prospect: foreigners raising money in dollars in China. “The development of that market is definitely encouraging,” says Chan. “But it remains to be seen when and how much the regulators would be willing to open it up, because it involves taking US dollars out of China and into the home country of these corporates, where the actual use of proceeds would be hard to monitor.” Additionally, the onshore swap market is not very liquid yet.

The Indonesian sovereign has been arguably the most interesting and important debt issuer in the world in the early months of 2009. In the space of a few weeks it reopened the international debt markets for emerging market countries with a $3 billion deal; then launched Indonesia on to the global Islamic financial markets with a $650 million landmark sukuk.

It has had to pay for its success, but its ability to raise such funds has not only eased the country’s capital position but made an important statement about investor confidence in it. The next question is whether this success can trickle down into the local debt markets when many companies have an urgent need of it.

When a Ministry of Finance team set off around the world in a non-deal roadshow in February, it did so knowing Indonesia had a lot on its plate. With world markets – both stock and credit – remaining in a mess, ministry staffers knew their country was facing a hefty debt load: total external debt of $149.1 billion, including short-term private external debt of $22.6 billion, with the sovereign itself needing to raise $4 billion swiftly to deal with its high budget deficit and provide stimulus to a flagging economy. Finance minister Sri Mulyani Indrawati led the team, and she presented well. “It was good to have the minister on the road,” says Fergus Edwards of UBS, who was on the roadshow. “She talks about the numbers. She doesn’t even appear to be spinning for a political audience.”

Across Europe, the US and Asia, questions came up about the size of the budget deficit, the country’s resilience in the face of commodity price shocks, tax revenues and sources of funding. “What they liked beyond any specific answer was the degree of detail around all those answers,” Edwards recalls. Additionally, Indonesia’s economy was starting to look relatively healthy by global and regional comparisons. “It’s interesting,” says a banker. “Indonesia during bullish periods tends not to grow as fast as the others, but when there is a financial crisis or a situation where growth is slower, it’s less affected by the external environment due to the fact that a lot of their economy is still domestically focused.” So by the time the roadshow was concluded, there was confidence that a deal could go ahead.

Getting one away was not straightforward. Historically Indonesia has launched its deals one at a time, which causes problems with market timing since every deal requires its own standalone documentation. This time, Indonesia had mandated UBS and Barclays Capital to set up a global medium-term note programme, which will allow it to issue at any time (the same banks were then mandated as bookrunners on the bond), but still ministry officials had to go back to parliament to get approval for any bond.

That proved to be unfortunate. On Friday February 13, with strong demand and markets about as good as could be expected given the broader environment, the deal went before Parliament; a swift approval would have allowed it to issue. “But then on Monday we got the very disappointing news that the parliamentary session would be postponed until a week later,” says Rahmat Waluyanto, director general of debt management at the Ministry of Finance. “It affected market sentiment and also the yield of the bond.” Markets became skittish in the meantime, thanks partly to renewed worries about the viability of Citigroup. “It might not have been ideal but given the legal constraints and the need to run a transparent process there was no alternative,” says Edwards.

The fallout of all of this was that Asia’s biggest deal since Hutchison Whampoa in 2003 got away in hellish markets, but at considerable cost. A US$1 billion five-year tranche priced at 10.375%, or Treasuries plus 850 basis points, and a US$2 billion deal priced at 11.625%, or 881 basis points over Treasuries. Market watchers reckon the delay probably cost the sovereign as much as 90 basis points on the 10-year deal. But in truth, particularly on the ground, there is little sniping about the deal. “It borrowed at cost, but at least it has borrowed,” says one senior foreign banker in Jakarta. It also demonstrated the depth of conviction that foreign investors have in Indonesia’s story: some 50% of the 10-year allocation went to the USA, and the bulk of it from long-only fund manager money. For his part, Waluyanto thinks that despite the widened spread, “we still managed to execute the transaction at a relatively tight new issue premium.”

Interview with Dato’ Mohd Razif Abdul Kadir, Deputy Governor, Bank Negara Malaysia

Dato’Razif, a more than 30-year veteran of Bank Negara, supervises regulation and development of sectors including banking, insurance, Islamic banking and takaful.

Public speakers on Islamic finance project different personas from the podium. Some are aggressive about the strength of the discipline compared to the conventional world; others are humble, recognising the gulf in scale between Islamic and conventional finance; some are a bit self-righteous, enjoying the lack of collapses among Islamic financial institutions as western banking behemoths crash and burn. Dato’ Razif: he’s just enthusiastic.

“I can talk for hours about this, days,” he says, flicking through a presentation he has made just weeks earlier at the University of Reading. His mantra is that Islamic finance is a source for stability, and he’s right, he really can talk for hours about the reasons: the direct link to the real economy; the lack of leverage; the ethical stance; the greater transparency and disclosure that comes from the additional level of Shariah governance; the greater fiduciary duties and accountability that come from the same source; and the different contractual relationship of the Islamic world, with equity-based and risk-sharing transactions rather than “a debt credit relationship where if you default I will go after you.”

One can argue at length whether Islamic banks have escaped the credit crunch more through luck or judgment, but Razif is in any event realistic that the sector has not emerged unscathed. “I always emphasise that Islamic finance is not insulated from what’s happening in the world,” he says. “The first phase of the crisis was not a problem because Islamic principles ensured there was no way [Islamic banks] would get hold of toxic assets. But the second wave, of underlying economic activity, has severely affected it. There’s no way any system can withstand it, and especially Islamic finance because the underlying has to be from those economic activities.”

So where do those principles leave sukuk today? Clearly sukuk issuance slowed in 2008: from RM121.3 billion of new issues in 2007 to RM43.23 billion in 2008, although the number of issues didn’t decline so much, from 59 to 47. “There is a lot of interest,” says Razif. “That’s not a problem. But the underlying market is very bad. It is so difficult to get the supply of dollars. This is nothing to do with Islamic finance: people are waiting to see the best time. A sukuk is a long term commitment and people don’t want to lock the cost, so in the meantime they’d prefer to access bank finance and then issue when it is settled and back to normal.”

Razif claims the interest is coming from both domestic and international issuers, and says there are “six or seven” issues waiting to come. Interestingly, he confirms an issue is in the queue from an Australian issuer, though he declines to name it; Australia is one of the many markets Razif and others have visited on roadshows to promote the idea of sukuk issuance in Malaysia. Another, unsurprisingly, is the Middle East.

Razif was delighted to see the issue last year from the Islamic Development Bank, the multilateral institution owned by many Middle Eastern nations, in ringgit. “It’s important because they are saying: Malaysia is a funding base. They know the market is so liquid. And for issuers you don’t want a one-off issue, you want your name to be known.” He cites the example of Toyota, whose most recent sukuk issue was a RM1 billion private placement in May. For companies like that, he said, the ringgit market (and particularly the Islamic ringgit market) present a strong source of liquidity and usually of pricing, so “even after the swap it’s cheaper.”

Like the conventional markets, sukuks have a problem with swap market capacity. “That is a global phenomenon, not only Malaysia,” he says. Is it capacity or cost? “Both. Supply is quite difficult,” he says.

Bank Negara is the driving force behind the Malaysia International Islamic Finance Centre (MIFC), which has now issued eight fully-fledged fund management licences, with the latest going to Aberdeen Asset Management, Nomura and CIMB Principal. Each has been given seed capital – the amount varies depending on “their commitment”, Razif says – and mandates, with the hope that in time they will then bring further capital to Malaysia from outside it. That, if it happens, should increase the liquidity still further.

Hyundai Capital Services hit two landmarks when it launched a RM650 million deal on May 20. It became the first Korean corporate issuer in Malaysian ringgit; and it raised the biggest single tranche by a foreigner in that currency.

Getting there was not especially straightforward. True, the three year senior unsecured fixed rate deal was launched amid a flurry of Malaysian interest in foreign issuers: Kexim had already been in the market by that stage, and Industrial Bank of Korea, so the interest of local investors in Korean names was already established. “The deal was based on elevated appetite from onshore investors for both the Hyundai Capital name and for Korean names in ringgit generally,” says Jan Wipplinger at Deutsche Bank, lead manager on the deal.

But that popularity brought a problem too. All Korean issuers, Hyundai included, needed to swap funds out of ringgit – in Hyundai’s case first into dollars, and then on to won. The problem was that by then the wealth of interest from Korean names in Malaysian issues had already had an effect on swap market capacity and pricing. In early April, Hyundai decided the widening basis swaps on both cross-currency trades made the deal uneconomical and delayed it.

As it happened, it was just a question of waiting for the right time, and when the circumstances came right just over a month later (the issue date ended up being May 20), the numbers were not just practical but enticing, and Hyundai upped the deal from a planned RM300 million to RM650 million.

Clearly, the credit was not the problem here, but the economics of the swap. “We did a roadshow to get investors familiar with the name, and then just needed to wait a few weeks to get the right window for the market to open,” Wipplinger says.

Most Korean names up to that time had had at least some state backing and had proven attractive to Malaysian pension funds. Hyundai Capital, lacking that backing, instead appealed to a different group of investors: fund managers, insurers and banks.

That said, there is an element of top-drawer backing in Hyundai Capital: the fact that GE Capital, with a AAA rating, holds a 40% stake in the company. This is believed to have proven attractive for the issuer in many of its offshore deals in recent years, and doubtless didn’t hurt in Malaysia either.

It proved a useful deal for the market, demonstrating there was still life in ringgit for Korean borrowers, and within weeks the issue had been joined by a RM380 million two-tranche bond from Woori Bank. While that might seem to owe more to the IBK and Kexim issues that preceded it, in some ways Woori had more in common with Hyundai: IBK and Kexim are both state-owned government policy banks, Woori and Hyundai represented pure commercial risk. Pricing was reasonably similar between the two as well, with Hyundai Capital’s deal paying 5.5%, and Woori paying 4.68% and 5% on three and seven-year tranches respectively.

Later in the year, Hyundai was back. On September 24, with the US stock markets in utter turmoil, it launched a RM205 million further drawdown off what is a RM2 billion MTN programme. This deal, a private placement of 1.5 year notes, was led by CIMB. This time the deal paid 6%, by which time its three-year notes were trading at around 6%.

Getting any such deal done in those markets was an achievement, and the private placement model appeared to be the only workable method at the time (and arguably still is for a foreign, non-state-backed credit). While the recap was watched closely, bankers were reluctant to read into it any improvement in the market for foreign issuers in ringgit, and so it proved: there would be no other foreign issue in the public markets for the rest of the year.

The notes carried a rating of AA1 from RAM, a rating that would struggle to find an audience in a public deal in today’s markets. But the size of the MTN programme suggests the issuer will be back sooner rather than later when markets allow. Merrill Lynch arranged the swaps on this second deal.

Take a look at any area of Islamic finance in Malaysia and there will be a statistic to support its success. Banking? There are 16 Islamic banks, 11 Islamic windows, four international Islamic banks. Insurance? Eight takaful, four retakaful and one international takaful operator. Fund management? Malaysia had 149 Islamic unit trusts at the end of 2008, the highest number in the world, with RM17.19 billion of assets, ranked second in the world after Saudi Arabia.

And the Islamic capital markets provide the most compelling evidence of all. As of September 2008, 64% of all total sukuk outstanding worldwide were from Malaysia, and, while 2008 was much quieter for new issuance, the country still accounted for 36.92% of new launches that year, still the highest chunk anywhere in the world. Malaysia has pushed sukuk with vigour, to the point that 57% of outstanding corporate bonds in Malaysia take the Islamic form. Between 2001 and 2007 there was an average annual growth rate of some 22%. Along the way Malaysia was home to the largest sukuk issue ever launched, for Binariang, at RM 15.35 billion.

More than that, sukuk is an area of clear innovation in Malaysia. Exchangeable sukuks have been launched by groups including, repeatedly, Khazanah; Maybank in 2007 came out with the world’s first international subordinated sukuk; and Malaysia was also home, back in 2002, to the world’s first global sovereign sukuk.

“It is the deepest and broadest sukuk market anywhere in the world,” says Badlisyah Abdul Ghani, CEO of CIMB Islamic. “There is nowhere else you can find a 50-year sukuk. There is nowhere else you can find a RM15 billion sukuk, a straight sukuk, a stapled sukuk, asset-backed securitizations, subordinated sukuks. Whatever you can find in the conventional bond market you can find in the sukuk market in Malaysia.”

Malaysia has achieved this by making an effort to build the most sophisticated regulatory environment in the world for Islamic finance. It has been able to do so because of a combined view at government, central bank and regulator level – in the form of the Ministry of Finance, Bank Negara Malaysia and Securities Commission – that combined action was needed to make it work. Separate interviews with Bank Negara and the Securities Commission in this guide give a sense of how seriously they take it.

International issuers have started to take notice. Ever since Shell launched the first ever Islamic corporate bond in ringgit in a private placement in 1990, Malaysia has sought to attract international issuers to its markets, and that approach has gathered pace through 2004 (IFC, the first ringgit sukuk by a supranational) and 2005 (World Bank, the largest supranational deal in ringgit to that point), until it really took hold in 2007. Issuers since then have included Japan’s Aeon Credit Services and Toyota Capital, and the UK’s Tesco Stores.

Additionally, this is one area where Malaysia’s long-held ambition to attract capital from the Middle East is bearing fruit. In recent years two major Gulf issuers, the Islamic Development Bank and Gulf Investment Corporation, have raised funds in ringgit, although GIC’s maiden issue was a conventional deal. Some managers boast lengthy lists of Middle Eastern institutions in varying states of readiness, some with rating in place and due diligence done, waiting for the right market conditions to return or for a private placement opportunity. “We’ve got a healthy pipeline from the GCC looking for ringgit issuance,” says Abdul Ghani.

For all the recent success, though, the sukuk market has not been immune from problems in the conventional markets. “You can’t really segregate the sukuk market from the broader bond market,” says Abdul Ghani. “It exists in the same market space, it goes after the same investor base, albeit there are Islamic investors who chase sukuk. Broadly the same forces that influence the debt capital market influence the sukuk market.” That’s evident in new issuance volumes: There were 47 sukuk worth RM43.23 billion issued in 2008 compared to 59 worth RM121.3 billion in 2007. Also, the same problems in the swap markets that inhibit foreign borrowers from approaching conventional ringgit deals apply in Islamic ones too.

That said, Malaysian markets generally have not suffered anything like the same ructions as those elsewhere in the world. “In Malaysia, both the Islamic and conventional markets were not as affected by what happened elsewhere in the world,” he says. “There were no toxic assets.” Malaysia also boasts the only sukuk market in the world with meaningful secondary trading.

A year ago, Malaysia was enjoying a remarkable influx of foreign issuers raising capital in the ringgit debt markets. As G3 credit markets locked up and Asian issuers began to look for the widest possible range of funding sources, Malaysia seemed to have seized an opportunity to prove its depth, sophistication and flexibility.

One year on, it doesn’t look quite so rosy: investor appetite has changed as it has all over the world, and swap market pricing has turned against most potential issuers. But even in this environment deals are getting done, and Malaysia’s role as a credible funding source for foreign issuers is likely to remain a permanent fixture when the dust settles on today’s market volatility.

Foreign issuance in ringgit debt dates back to the Asian Development Bank in 2004, or arguably even to the Shell Islamic private placement back in 1990, but last year’s cluster of issues was kicked off by Export-Import Bank of Korea, or Kexim (see deal profile). The RM1 billion Kexim raised in five and 10-year funding in March 2008 through RHB, CIMB and OCBC demonstrated clearly that the bulging liquidity in Malaysia was prepared to find a home in foreign paper, provided it was the right kind of paper.

By April it had been followed by a RM1 billion three-tranche deal from Industrial Bank of Korea, led by RHB and CIMB. This was in some respects a similar deal: a Korean policy bank, with state backing, which was enough to give Malaysian investors comfort about the creditworthiness of the issuer. Later deals, though, would show a greater daring among investors. Hyundai Capital Services, a corporate borrower with no state backing (but part-owned by AAA-rated GE) raised RM650 million through Deutsche in May, followed later that month by a three-tranche, RM530 million deal for Woori Bank through RHB and CIMB.

Alongside this Korean influx came some promising signs that Gulf institutions were willing to issue in ringgit. In January 2008 Gulf Investment Corp succeeded in raising RM1 billion in a dual tranche deal led by ABN Amro (now RBS) alongside RHB Bank and Standard Chartered; GIC is an investment company owned by the six nations of the Gulf Cooperation Council. This was a conventional issue, and was followed in August by a sukuk from Islamic Development Bank, which raised RM300 million for IDB projects in Malaysia in an issue of five-year notes. CIMB and Standard Chartered led this deal.

But these were the good times: high liquidity, investor appetite for foreign names, attractive pricing both in terms of the local markets themselves and the swap markets to get the proceeds out again. Nothing good lasts forever, and it didn’t.

Markets are nothing like as easy now for foreign issuers as they were then. “Liquidity for foreign issuers is becoming very limited, for a few reasons,” says Seohan Soo, head of debt capital markets at AmInvestment Bank. The first is that there are very good opportunities for investors among local issues. “If I invest in Cagamas rated bonds today, I’ll get MGS plus 80 to 95 basis points for a 10 year deal. There’s no compelling reason for investors to take riskier assets for a slightly better return.”

Besides, investors are focusing on protecting capital (hence the flood of government guaranteed bonds in the market – see the next article for more). “So investors are looking at local issuers whose credit they are familiar with, and they have the comfort of knowing that the assets reside in Malaysia. On the other hand, if you buy a bond from a Korean state-owned bank with zero assets in Malaysia, a credit downgrade or default would actually be a much bigger risk for them. This is an added disincentive for investors to invest more in foreign names.”

Tan Ai Chin, head of investment banking at OCBC Malaysia, adds: “There is still a market for foreign issuers but investors are a lot more cautious about the underlying credit profile of the issuer and also the economic fundamental of the domicile country.” In her view it is unfortunate that most of the foreign issuers who have come to market have been financial institutions, which is probably the sector under most scrutiny from investors today.