Malaysian Prime minister Najib Razak has defended his ability to push through transformative reforms despite concerns locally that they could lose him office.

“I strongly feel that my government has the necessary support to push our reform initiatives forward,” he told Emerging Markets in an exclusive interview. He added that Malaysians would demand reform. “They desire a massive transformation,” he said.

In March Mr Najib launched an ambitious program called the New Economic Model, which seeks to make Malaysia a high-income economy with developed nation status by 2020 with a more than doubling of national per capita income to US$15,000. Significantly, Mr Najib has sought to end many affirmative action policies – originally implemented by his father, Tun Abdul Razak, when Prime Minister in 1971 – such as a requirement that 30% of equity in new share offerings must be allocated to Bumiputras, or ethnic Malays.

The reforms – which many feel have been prompted by Malaysia’s opposition coalition, led by Anwar Ibrahim, winning an unprecedented one third of the seats in parliament in the 2008 general election – have been widely welcomed by international analysts. But some feel that established interests in Malaysia will try to push Najib out of office rather than allow such change. “People who have had their snouts in the trough for such a long while are not going to take it lying down,” said an analyst in Kuala Lumpur.

“I agree this is no easy task,” Mr Najib said. But “Malaysia’s future prosperity depends on our ability to create an environment conducive to innovation and investment. The NEM… depends on our ability to provide equitable treatment for all businesses, ethnic communities and groups.” He said the NEP will “be based on needs and merit, and not simply race.”

 Mr Najib is attempting to effect change without losing the vital support of the Malay majority, and stressed: “We are not dismantling any type of support for the Bumiputera, who are often those who need it the most.” But he offered an unusually stark admission that policies have previously enriched a few and not served the majority, saying he must “make sure that government support will not get wasted in rent-seeking and patronage behaviours by a few privileged individuals.”

Specific measures include the launch of a Government Transformation Programme which will involve “improving government efficiency, an immediate crackdown on street crime, tackling corruption and a complete eradication of hardcover poverty by the end of 2010.” Other measures include childhood literacy improvements, welfare reform, and smaller government with greater partnership with the private sector. A new taskforce, PEMUDAH, has been launched to cut red tape and make it easier to do business in Malaysia. “We know that the era of ‘government knows best’ is over,” Mr Najib said.

 In one measure sure to divide opinion, the NEM will reduce subsidies, including oil. “Malaysia is one of the most subsidized nations. We know that this is not a responsible course.”

Malaysian society has been uncommonly tense this year, with attacks on Hindu temples and international concern about a second sodomy trial for Mr Anwar, who was imprisoned for six years on a similar charge that was subsequently overturned in 2004. Mr Najib said Mr Anwar “deserves to have a fair and impartial trial” independent of the government and added: “The government views this trial as a distraction from its important work of modernization and reform.”

Malaysia has one of the region’s largest local currency bond markets, second only to Korea in ex-Japan Asia. RM52.4 billion, or over US$16 billion, of private debt securities were issued in 2009 – a 7.8% year on year increase, more than double the amount raised in Hong Kong and triple that of Indonesia, Singapore or the Philippines.

“2009 was a good year of recovery,” says Seohan Soo, Director and Head of Debt Capital Markets at AmInvestment Bank. “Despite a GDP contraction of 1.7% in Malaysia we managed an increase of 8% from the year before in the local bond market. This was a result of stimulus measures by the government of Malaysia coupled with the low interest rate environment in the local market.”

Market players and rating agencies locally were hoping for a strong 2010, with approximately RM55 to 60 billion of PDS for the year, but if that’s going to happen it certainly didn’t come at the start. Only  RM10.6 billion was raised in the first quarter of the year. “It is somewhat lower than expected,” Soo says. “That is a bit of a disappointment.”

Still, issuance appears to be picking up after a slow start. In April Bank Pembangunan Malaysia raised RM2.5 billion in an issue of three- and five-year government guaranteed notes, the largest bond issue so far this year, through CIMB and HSBC. Like most Malaysian debt deals, it was Islamic. In other important deals in recent weeks, Danga Capital – a subsidiary of Khazanah, the investment arm of the Malaysian state – raised RM2 billion in a five-year bond issue, also Islamic, off a RM10 billion Islamic MTN programme; UOB raised RM500 million in a lower tier two issue of 10-year non-call five bonds, the first lower tier two issue of the year; and Digi Telecommunications priced a RM250 billion five-year MTN issue.

“This year the banks are going to the debt market,” says Chay Wai Leong, managing director of RHB Investment Bank, who like many hopes for a good year for bonds. “Issues are getting good pricing and reception. There’s a lot of interest because investors are generally quite bullish on the currency, and are getting exposure through the bond and equity markets. There’s lots of demand for paper.”

In some respects Malaysia is an impressively diverse market; in others, not. On the impressive side of the equation is tenor.

Issuance tends to be skewed towards tenors of three to five years. “We see a lot of liquidity in the five-year tenor,” Soo says; at the time of the interview he was working on a five-year $500 million deal for Cagamas Berhad. But the curve actually goes much further than that. Demand and liquidity for longer-dated bonds is strong, in particular from insurance companies and pension funds in the local market. In 2009 AmInvestment Bank Berhad was sole lead manager on a 30-year government-guaranteed RM5 billion deal  for 1Malaysia Development Berhad. The deal set a new benchmark as the first and largest bond issue ever to be guaranteed by the government of Malaysia. “That is something unique about the Malaysian market,” says Soo. “Liquidity for PDS goes up to 30 years, particularly for infrastructure projects. In other Asian markets you’d be lucky to get a 10-year bond.”

This is perhaps particularly notable on the Islamic side. “We are the only one with a curve from one month to 50 years,” Raja Teh Mainmunah, head of global Islamic markets at Bursa Malaysia, says. “For everyone else it’s just the sweet spot of five years. You cannot manage your borrowings on five years, especially if you are a government: it’s not enough.”

Also, there is a range of structure and rating available in Malaysia. “Banks have been issuing some hybrid tier one and lower tier two subordinated debt in the past two years,” says Soo. Securitization, too, is making a comeback, with a pipeline of residential mortgage backed securitisation transactions in the market. AmInvestment Bank has been actively involved in Tresor Assets Berhad, a RM1.5 billion asset-backed securities programme. “This monetized civil service uncollateralised loans into a pool of ABS rated AAA bonds with maturities of up to 10 years,” says Soo, whose team joint-led the deal. “Since 2008, market demand has been rather weak but we are seeing a revival of interest from investors.”

On the negative side, there are some challenges with the Malaysian market, chiefly that it is very top-heavy. In 2009 98% of public debt securities issuance was rated AA or higher (based on local ratings), including subordinated debt from financial institutions; 55% were government guaranteed or triple A. Only 1% each was rated A or BBB. Nothing much is changing: in 2010 to date, 96% of bonds are rated AA and above.

“Over 90% of PDS in our market are rated AA and above on the local rating spectrum,” says Soo. “Liquidity tends to be very limited for PDS rated A and below.”

To this end, the government launched a credit wrap agency called Danajamin, which applies a triple A wrap around securities from lower rated companies, both on conventional and sukuk issues, in return for a fee. (It is 50% backed by each of the Ministry of Finance and, through Credit Guarantee Corporation Malaysia Berhad, Bank Negara Malaysia. Technically it does not represent sovereign risk, but a special purpose vehicle.)

This was established as a national financial guarantee institution under the RM60 billion Second Stimulus Package announced by Prime Minister Najib Razak on March 10 2009. “Its objective is to provide credit enhancement to investment grade issuers having difficulties accessing the bond market via financial guarantee insurance,” says Soo; under the scheme, total bonds of RM15 billion are expected to be raised in the local bond market. “This creates a new supply of bonds,” says Soo. “We could see more transactions coming through Danajamin credit enhancements, particularly on infrastructure financing.” AmInvestment Bank is working on the issuance of RM250 million AAA-rated Danajamin credit-wrapped Islamic securities for Kencana Petroleum Berhad, the first Danajamin credit-enhanced deal in Malaysia.

Islamic paper is dominant in Malaysia. Sukuk issuance is 59% of total PDS issuance in the market, according to AmInvestment Bank, or RM31.2 billion. Soo estimates it will continue to account for more than half the total PDS issuance in Malaysia.

Globally, the sukuk market has gone through “a U-curve sort of trend,” says Mohd Effendi Abdullah, Director and Head, Islamic Markets at AmInvestment Bank. Global sukuk issuance went from around US$31 billion in 2007 to $14.1 billion for 2008 and $20.2 billion in 2009. “The market is looking for 2010 to be about $20 to $35 billion, that kind of number,” Effendi says.

But through the crisis, Malaysia remained a fairly constant issuer, occupying a greater proportion of global issuance as issuers in Dubai and elsewhere in the Middle East ran into trouble. Malaysia enjoyed about $10.5 billion equivalent of sukuk issues in 2009, Effendi says: 52% of the global total. He expects Malaysia to continue to be half the world total in 2010 too. “We expect Malaysia to be the leader and account for the majority of global issuance.” Most of it will no doubt be in ringgit, but there are also prospects in US dollars.

It’s also enormously impressive for its variety. “We have all types of sukuk in the market: straight sukuk, hybrid, sub debt, exchangeable, whether it’s one month or 50 years,” says Badlisyah Abdul Ghani, CEO of CIMB Islamic. “Issuers from anywhere in the world can come and use the Malaysian platform to do all the available types of sukuk and tenors. The regulatory framework is already there to facilitate it.”

This success has been achieved largely without international participation in the domestic market – and not necessarily for lack of interest from foreign investors.  “This is the peculiarity of the Malaysian ringgit sukuk market,” says Maimunah. “Generally issuers are not the least bit concerned about going out [of Malaysia for funds] because there’s sufficient liquidity in the Malaysian market. There are fixed deposits of half a trillion. Issuers think: if I go out, I have to prepare my offering circular in a different way – I’m not bothered.”

There have been exceptions: $1.5 billion of the $4.5 billion Petronas jumbo deal  in August was a sukuk, and Khazanah also has a track record of targeting overseas investors. (On the conventional side, Axiata’s US$300 million Regulation S deal in April was the first offshore corporate bond from Malaysia since the Petronas deal.)  “If you are a Malaysian looking for RM200 million, there’s no point in looking overseas, but if you are Petronas, it makes more sense,” Maimunah says.

For this reason, some would like to see bigger deals done to tap all available demand. “We might want to see bigger ticket deals done in our capital market to cater to both domestic and foreign investors,” says Badlisyah. “Malaysia is ready to cater to those deals.”

One potential sukuk issuer that would certainly grab attention overseas is the sovereign itself, and some consider Malaysia overdue for a new sovereign bond. It last issued in 2002, with a five year $600 million sukuk issue. Bank Negara clearly wants to see the state come back: Governor Zeti Akhtar Aziz told reporters in March: “Malaysia has not tapped the international capital market for a long time, whether in conventional or sukuk bonds. Therefore, we have encouraged the government to do so because it’s important to have the Malaysian name in the market as well as to create a benchmark for other corporates.” Today, the only outstanding foreign debt is a 7.5% 10-year note maturing in July 2011. Instead, the Petronas deal is the only recent paper that gives some level of sovereign exposure.

The structure of sukuk has been a key point of difference between Malaysia and the Middle East. In Malaysia, the most common structures are musharakah and mudaraba. But these sorts of structures are less common in the Middle East, where the structure is more commonly ijarah and murabaha. This is partly because of a pronouncement by a scholar in 2008 arguing that most non-ijarah structures were not Shariah compliant.  Despite this difference, Effendi does not expect much change. “The musharakah and mudaraba will continue in Malaysia,” he says. “But the detail for the structuring will be enhanced to cater for both sides, Malaysian and Middle East compliance. More innovative structures will come out.”

Mainmunah would like to see more international issuers coming to Malaysia for funds. “Corporate America is looking outside to raise money; we’d like to see more issues from there coming through. We’d also like to see Asian corporates tapping the Islamic markets. This could be a good avenue for Australian corporate too, from a country with commodities, real assets.”

The quest for foreign issuers has occasionally been more fruitful on the conventional side – particularly Korean borrowers – but momentum is shifting towards Islamic markets. “This year we’re looking towards getting more foreign issuers in Islamic markets,” Soo says. “As part of the MIFC initiative we are also working towards getting more foreign issuers including supranationals to issue ringgit and foreign currency bonds in Malaysia.”

Multilaterals were among the pioneers in this market: the Asian Development Bank’s 2004 deal here was the first major cross-currency swap since the Asian Financial Crisis. Otherwise, foreign issuers in ringgit have chiefly been Korean banks, who came in a flurry at a time when they were constrained for liquidity elsewhere.

Wherever it comes from, there is room for growth. “Our ratio of total debt securities to GDP is about 80%,” says Soo. “In a developed market it tends to be 100% or more. With that, there is a growth potential of another 20% in both public and private debt securities in the Malaysian bond market in the coming years. I think we should get there in the next five years.”

Malaysia has one of the region’s most mature asset management industries. Boosted by the rebound in equity markets, assets under management grew by 40.9% in 2009 to RM315 billion, while the unit trust industry – the largest part of it – rose 47% in net asset value to RM191.7 billion.

While much of this was a function of market movements, the market didn’t account for all of the increase: RM24.8 billion of the increase was new inflows into unit trusts. “Industry penetration rates remained high at 19%, reflecting the increasing maturity of Malaysia’s unit trust industry,” says Tan Sri Zarinah Anwar, chairman of the Securities Commission. Penetration rates measure the net asset value of the unit trust industry against the market capitalization of the stock exchange.

The Securities Commission has long believed that Malaysia’s asset management industry will benefit from increased foreign participation and competition. For several years it has been licensing foreign fund managers, particularly on the Islamic side, and even seeding them with capital, in the hope that this will in turn attract international funds to be managed from Kuala Lumpur. Asset management has arguably been the most active part of the Malaysia International Islamic Financial Centre (MIFC), which seeks to make Malaysia a hub for international expertise – and international capital – in Islamic finance. Seven new Islamic fund management licences were issued in 2009, and a mutual recognition agreement signed with the Securities and Futures Commission of Hong Kong for the cross-border distribution of Islamic fund products. “The attractiveness of Malaysia as an Islamic fund management hub was reaffirmed by continuing strong international interest to establish operations in the country,” Zarinah says. So far 12 Islamic fund management licences have been issued in total.

Those who have built joint ventures with foreigners are by and large pleased with the results. “It has worked out very well,” says Datuk Noripah Kamso, chief executive of CIMB-Principal Islamic Asset Management, of the joint venture she oversees. “It came about as a result of the Principal Financial Group being happy with its joint venture in the conventional space with CIMB Group in southeast Asia,” she says. “That, combined with the MIFC’s comprehensive legal and regulatory framework for global Shariah aspirations, led the Principal Financial Group to believe that a 50% stake in an MIFC-initiated licensed entity headquartered in Kuala Lumpur would be a perfect base for their entire global Islamic asset management business.”

Other foreign groups have come to a similar conclusion. Nomura Asset Management was one of the first foreign fund managers to receive a licence in the wake of an announcement at the Invest Malaysia conference in 2005 that several would be licensed. It followed Aberdeen Asset Management and has since been followed by others including BNP Paribas, Franklin Templeton and Reliance. Nomura has decided to base its Islamic presence globally in Malaysia. “What’s very attractive about Malaysia is it is still in its early stages,” says Nor Rejina Abdul Rahim, managing director for Malaysia at Nomura Asset Management. “It’s always been very much localised and most investments have been plain vanilla, so foreign fund managers have been able to come in and give a bit of excitement to the market. The French players are very good in structured products; we are the only Japanese player in town and have always operated in a low interest rate environment and so have a track record of coming out with ways to get better yields.” Foreigners have generally not opted for a retail strategy, although it’s possible some may do so in future, probably through tie-ups with local houses.

While MIFC has clearly succeeded in bringing in big names and expertise, the jury is still out on whether it has attracted much capital alongside the foreign managers to be managed out of Malaysia. However, everyone accepts this is a long-term process in its early stages. Datin Maznah, CEO, Funds Management Division, AmInvestment Bank Group, says MIFC is a success, “from a very low base of course. It has not yet acquired the momentum that would be more noticeable, but many fund managers – both local and foreign who are set up in Malaysia – do manage funds in non-ringgit assets from Malaysia.” AmInvestment Bank is among them, she says. “When foreign clients give us mandates it’s to manage non-ringgit assets,” she says. “Some of it flows to domestic, but it’s not usually a Malaysian mandate – Asian, perhaps.”

Foreign managers, naturally, feel MIFC has achieved plenty already. “I think MIFC has done a good job in creating the brand Malaysia,” says Rejina at Nomura.

“Yes, it has been a success,” adds Noripah at CIMB Principal. “The MIFC team follows through quite closely with a conscious and calculated intent to ensure affirmative actions with all MIFC stakeholders.” The licensing of the 12 asset managers helps, she says; “these managers are included in the database of global consultants like Towers Watson and Mercer and will therefore be on the radar of global institutional investors such as pension houses, sovereign wealth funds and takafuls.”

While Malaysia seeks to bring money in to the country, its biggest institutional funds are increasingly looking overseas. Prime Minister Najib’s new economic model included a commitment to increase the Employee Provident Fund (EPF)’s exposure to overseas investment, from around 6% to 10%. This has also been welcomed by foreign managers hoping to help it do so.

There is also scope for the development of a private pension market, something Malaysia is looking at developing. “There is an opportunity for everyone in terms of the deepening of the pension fund market here,” says Rejina. “If you think about it, you’ve got almost 28 million people here and everyone is reliant on EPF. If you look at the contributors there are approximately 12 million EPF members. But there are at least four million people – traders, hawkers – who are not covered by the EPF.” There is scope for the development of pensions to cater for people who fall into that gap.

Additionally, there’s a sense that EPF is perhaps too big and that the development of other major institutions, or a private pension alternative, would help the market. “EPF has about US$108 billion. In terms of trading volume it accounts for roughly 50% of Bursa on a daily basis,” says Rejina. “The market needs to have more players and it cannot rely on EPF alone.” Noripah says the EPF “makes up approximately 50% of the market capitalisation” and sees an opportunity here. “Managers with global investment capabilities are able to help them mitigate their concentration risk of investing in Malaysia by diversifying their investible assets into global markets.”

Rejina adds: “Definitely that third pillar [private pensions] needs to be done and done now, because the average Malaysian is still not getting enough to retire on.” Foreign managers like this idea too: for Nomura pension funds are already among their largest clients in the world, particularly those in Japan.

In terms of product, CIMB and Public Mutual have developed new Chinese Islamic equity funds, but otherwise the range of product available in Malaysia – both conventional and Islamic – is already sophisticated and diverse. If anything, innovation has perhaps shifted to fund structure, with the traditionally high front-end fees on unit trusts under scrutiny as some managers attempt to replace them with conditional back-end fees, which are not charged if an investor stays in the fund for long enough.

A look at inflows shows that fads tend to come and go, too. According to data provided by AmInvestment Bank Group, global equity unit trusts enjoyed a RM5.36 billion inflow in the year to March 2008, an RM81 million outflow in the year to March 2009, and a RM1.02 billion inflow in the 11 months to February 2010. Domestic equity income funds saw RM749 million of outflows in 2007-8, then RM419 million and RM590 million in inflows in the two successive years. Mixed asset growth funds were flavour of the month in 2007-8 before logging outflows ever since. Very few patterns are constant: only domestic Islamic equity funds have been consistently popular throughout that period, logging close to RM2 billion or more of inflows in all three years.

“Each year has a theme,” says Maznah. “Consistency in domestic Islamic equities comes through, but there are huge swings in global funds year on year.” A similar picture exists in fixed income funds: each of general bonds, Islamic bonds, closed end bond funds, and guaranteed funds (both conventional and Islamic) have experienced both good and bad times over the last three years, with swings of hundreds of millions of ringgit from inflows to outflows in successive years. Here, money market products have been the constant, with more than RM4 billion of inflows in both 2007-8 and 2009-10. “In the global crisis, everybody rushed for capital protected, and in the last few years money market has been a refuge,” Maznah says. “This year bond funds are showing signs of life for the first time in two years. Every year the pattern changes.”

Malaysia hosts the most sophisticated and entrenched Islamic finance industry in the world. It permeates all areas of financial services. 88% of Bursa Malaysia’s listed securities are certified as Shariah-compliant; the country hosts 150 Shariah-compliant mutual funds with RM22.08 billion in net asset value, equivalent to 11.52% of the whole mutual fund industry; and the total combined value of outstanding sukuk issues by December 2009 was RM172 billion, or 57% of the entire bond capital market.

Seventeen of Malaysia’s 39 licensed banking institutions are Islamic, with RM233.14 billion in assets between them as of February 10. Rather than being an adjunct to conventional commercial banking – an offshoot, niche offering – Islamic finance has become very much part of the Malaysian mainstream and is expected to continue to grow.

It’s a point of pride to the country’s regulators. “Today, Malaysia has a comprehensive and well-developed Islamic financial system, including a vibrant banking and takaful sector, and well-developed Islamic capital and money markets that operate in parallel with the conventional system,” says Dr Zeti Akhtar Aziz, Governor of Bank Negara Malaysia. “Our sukuk market is the largest in the world.”

And if Malaysia’s financial services industry weathered the financial crisis well, the Islamic component did particularly well. “From an Islamic perspective we were fairly insulated from the financial crisis, predominantly because Malaysian Islamic finance players, who are mainly domestic, were not involved in the US sub debt industry,” says Badlisyah Abdul Ghani, CEO of CIMB Islamic. “Also, a slowdown in global Islamic capital markets doesn’t have a negative effect on the Malaysian sukuk market. The level of confidence here is very high: the market has been here since 1990, unlike the international Islamic capital market which dates from 2002.” Developments in the sukuk market are discussed in more detail in the debt capital markets chapter of this guide, while the international fund managers who have come in partly to service Islamic clients are discussed in the asset management section.

Having built a strong domestic industry, the emphasis of recent years has been on turning Malaysia into an international Islamic centre. One sees this in two directions: liberalisation of financial services, allowing more and more foreign entrants to participate; and attempting to attract international capital flows.

Malaysia has long held a more liberal stance on the Islamic side of its banking sector than the conventional, particularly when it comes to foreign participation. In 2009 the foreign ownership limit at local Islamic banks, investment banks and insurance companies was raised from 49% to 70%. Already Malaysia has licensed three wholly-foreign-owned Islamic banks: Kuwait Finance House, Al-Rajhi Bank, and Asian Finance Bank (majority owned by Qatar Islamic Bank). Each of them has built significant operations on the ground, with models varying from corporate finance to a full retail offering. Other financial institutions at least partly owned by foreign houses include the Islamic units of HSBC (HSBC Amanah Malaysia), OCBC (OCBC Al-Amin Bank) and Standard Chartered (Standard Chartered Saadiq).

There is more to come. Last year Bank Negara announced two so-called “mega-bank” Islamic banking licences would be awarded to overseas lenders with capital of more than US$1 billion, alongside new permits for Islamic insurance, conventional global banking and conventional specialized banking. These mega-banks can be 100% foreign owned, provided they become locally incorporated in Malaysia. Bank Negara said at the time the new licences were “to enhance global interlinkages, leverage on global developments in Islamic finance and reinforce Malaysia’s position as an international Islamic financial hub.”

In March Bank Negara Malaysia governor Zeti Akhtar Aziz said candidates had been shortlisted and it is a subject of great conjecture who they might be. They must presumably either be the Islamic arms of multinationals like HSBC or Citi, or some of the more powerful Middle Eastern institutions, although the obvious Middle Eastern candidates – Kuwait Finance House and Al Rajhi – are already here.

The most visible example of Malaysia’s international aspirations is the Malaysia International Islamic Financial Centre (MIFC), launched in August 2006 to promote the country as a hub for international Islamic finance with the backing of government, regulators and financial institutions. Under MIFC, several foreign institutions have been given incentives, varying from tax breaks to relaxed ownership restrictions, to come and set up Islamic businesses in Malaysia. Some fund managers have been given seed capital sourced from the Employee Provident Fund. MIFC embraces sukuk origination, Islamic fund and wealth management, Islamic banking, takaful, and human capital development.

MIFC has certainly attracted plenty of new expertise: on the asset management side, for example, some of the biggest names in the business, such as Templeton, Nomura and Aberdeen, have set up. As a marketing exercise it has indisputably succeeded, but some feel that it has yet to do what it really set out to do and attract international capital to be managed from Malaysia (see the asset management chapter for fund managers’ views on capital flows).

But perhaps it’s just a matter of time. “The drive to develop Malaysia as an international financial centre is a relatively new exercise, slightly above two years,” says Badlisyah. “I can attest that in that short period of time we do have evidence of strong interest from investors from overseas to invest in Malaysia or through the MIFC.” 

Innovation in product development, too, has tended to shift towards cross-border initiatives. The most obvious example is hedging for movements in currencies or interest rates between markets. “Over the last two years the Malaysian market has introduced a number of hedging instruments in the market to give more appropriate risk management for Islamic finance,” says Badlisyah. “Malaysia is the only country that has the Islamic master agreement, a standardized derivatives agreement based on ISDA documentation, established in the market.”

So far, these structures have chiefly been domestic. “When you do cross-border investments, those hedging requirements become more sophisticated than what is typically available in the Malaysian market,” Badlisyah says. “But we are focusing on developing greater capacity for hedging – considering that MIFC is there to facilitate cross-border activities – and those products should be coming out fairly soon.”

Developments like this take time. “Hedging has been on the drawing board for quite some time,” says Mohd Effendi Abdullah, Director and Head, Islamic Markets, at AmInvestment Bank. “People are cautious about hedging instruments, especially after what happened in the US, but it is being looked at.” Mohd Effendi also welcomes the arrival of Bursa Malaysia’s commodity trading platform (see box).

Malaysia has the right infrastructure, the right regulatory backing, the right experience and the right assets to build Islamic finance further and further. So where’s the weak point? Possibly in human resources, and more specifically, in Shariah scholars – the people who sign off on the Shariah compliance of structures and funds.

Certainly, Malaysia has made more effort than most countries to develop professional expertise in Islamic finance – worldwide, perhaps only Bahrain comes close. “We have invested in human capital development to ensure a deep pool of talent and expertise to support the development of Islamic finance,” says Governor Zeti. In particular, Malaysia has established the International Centre of Education in Islamic Finance (INCEIF) and the International Shariah Research Academy (ISRA) as part of its attempts to support advanced education and research in Islamic finance.

Malaysia is unusual in insisting that no scholar can serve on the board of more than one bank – in stark contrast to practices in the Middle East. The idea of this is to force the development of a greater field of scholars in Malaysia, rather than just a small group – potentially a cartel – of people who do everything. It will, though, take time for this policy to mature and in the meantime there is a bottleneck.

Practitioners are already thinking further ahead. “A critical aspect to ensure our long term success as a financial centre is the management of Shariah committees and the Shariah profession,” says Badlisyah. “Malaysia is the only country in the world that has an official Shariah guideline in terms of how Shariah committees are managed, how members are appointed, the qualification required and how banks need to operate their frameworks internally.

“What is missing I believe is the next step in enhancing the industry, to ensure Shariah professionals are deemed professionals in the same manner as lawyers, medical practitioners and accountants, where they have their own self-regulating professional bodies, perhaps even their own legislation. This will enhance confidence in the market and boost Malaysia’s position as the best place to do Islamic finance.”

Building a corpus of Shariah expertise and attracting cross-border flows are perhaps the two biggest challenges facing Malaysia now, but on all counts there are reasons to be positive about development.

“I think this will be quite an exciting year for the Islamic finance industry,” says Mohd Effendi. “Having opened up the industry, local participants will be encouraged and given a catalyst to run faster. I expect a rapid pace of development this year.”

BOX: Bursa’s Shariah challenge

Last August Bursa Malaysia launched a major new Islamic initiative called Bursa Suq Al Sila’. This is an end-to-end commodity trading platform designed to be Shariah compliant, in order to meet the needs of commodity financing and liquidity management both domestically and, increasingly, cross-border.

It uses the Islamic structures of murabahah, tawarruq and musawwamah, and is billed as the first exchange of its kind to encompass a hybrid market, allowing participants a choice between an automated electronic exchange system and traditional voice broking.

The exchange has begun to garner some cross-border success: Gatehouse Bank conducted the first international transaction last year, and is said to have been followed by a number of trades from GCC institutions. “We’ve had daily trades,” says Raja Teh, “and we have a good track record of GCC trades. They still come through Malaysian banks but they are essentially cross-border. So the next phase is to try to admit these GCC banks as members so they could trade with each other: they still use bilateral arrangements now.” Trades have been conducted in ringgit, US dollars and GCC currencies.

While the exchange purports to be Shariah-compliant, that is not an entirely straightforward claim to make. Last April, before the exchange was launched, the Shariah scholars at the influential Fiq Academy in Jeddah issued a fatwa saying that organised tawarruq were prohibited. This appears to undermine the exchange’s Shariah compliance, as the use of an organised bid is, as Raja says, “an inherent feature of the exchange”.

Bursa’s approach has been to look at the reasons they think underpin the fatwa and attempt to address them one by one within the exchange’s structure. “Generally we believe the pronouncement stems from the fact that there had been a couple of fraudulent trades” using tawarruq structures, she says, such as warrants backed with futures contracts, which are definitely not Shariah compliant. But she is adamant that Islamic finance needs a commodity financing exchange. “From an Islamic banking perspective, if we don’t have that, how are we going to manage liquidity, because there’s no instruments available at this point in time.” The market appears to agree with her, as banks have continued to use the platform despite the Fiq pronouncement.

It doesn’t appear that commodity murabaha themselves are the problem: AAOIFI, the main standard setting body for Islamic finance in Bahrain, has issued guiding principles on them. Instead, Bursa has focused on regulating trades to avoid fraud, or trades where the underlying asset isn’t really there. “Commodity suppliers must have a real spot commodity. Because we are a regulator, we can compel an audit at any point in time.” The exchange is also requiring buyside members (the financial institutions) to sign an undertaking that the financing they raise from trades on it will only be used for Islamic finance. Raja doesn’t think that prohibiting trades on the grounds of being organised holds up. “The premise is: clients have now ended up with a commodity that they don’t have any real use for, and which they need to sell for cash – this is the tawarruq element. Scholars are concerned that the trade is organised from day one and therefore not real. But it is real, because the exchange takes it and sells it back to the market.”

Philosophically, standing in the way of this organised approach makes little sense, Raja says. “Where in any of the [Islamic] sources does it say that being organised is haram? Are we saying the more haphazard we become the more Islamic we are? It’s not about organisation, it’s about whether the trade is real, and we are trying to address that through the exchange.”

Practitioners seem to side with Bursa. “The tawarruq principle is quite broad,” says Mohd Effendi at AmIslamic Bank. “It depends how you utilise that principle. In certain parts of the Middle East they are against that product because they say you are using the same asset, transacting with the same parties, and it’s an organised transaction. But with Bursa they have made it a true sales transaction by using the commodity market, with a tripartite arrangement instead of two parties. It is more acceptable.”

A paper expressing Bursa’s position will be presented to the Islamic Financial Services Board annual summit in Bahrain in May, and in time the exchange hopes it can go back to the Fiq academy with an explanation of what it has done and get a more favourable ruling. In the meantime, the technical lack of Shariah compliance with Fiq does not appear to be keeping the industry away: trades on any given day on the new exchange are typically between Rm500 million and 2 billion. The potential is far bigger: pre-crisis, Raja estimates that as much as $100 billion per day of commodity murabaha trades were being conducted, chiefly in the Middle East, all of them through laborious bilateral agreements through commodity brokers.

The economic picture is brightening in Malaysia. Reasonably resilient through the financial crisis, it also appears to be emerging from it much faster than developed economies.

After a 1.7% contraction in GDP in 2009, the World Bank is now forecasting 5.7% growth for Malaysia in 2010, and growth in the 5 to 6% range for the following two years. Some are more euphoric still. Consider this note from HSBC economist Robert Prior-Wandesforde in April. “We have had a consensus-busting 6.8% 2010 GDP growth forecast for the past six months, but have now decided to change it – in an upward direction.” HSBC is now calling for 7.3% growth this year.

Others are not quite so bullish but nevertheless positive. Lee Heng Guie, chief economist at CIMB Investment Bank, expects 4.8% full year growth, expanding to 5.5 to 6% in 2011 to 2015. “Amid the unpredictable external forces, we believe the accelerated pace of government and economic transformation programmes to make the economy more competitive – and the business, economic, regulatory and oversight system more efficient and sensitive to new developments – should boost the country’s growth potential,” he says.

Several key economic indicators are turning positive. The Industrial Production Index (IPI), a barometer for the manufacturing sector, has registered positive growth for three consecutive months. Exports rose 27.6% in the first two months of 2010 compared to a year earlier, reversing a 16.6% fall through 2009. “When you put these together with other indicators such as consumer confidence, we think Malaysian economic growth for the first quarter could be near 10%,” says Manokaran Mottain, senior economist at AmInvestment Bank Group. “If that is right, then I would say full year growth for this year will be much better than the government estimates of 4.5 to 5.5% or even the prime minister’s target of 6%. I think we can achieve more than that.”

Malaysia emerged reasonably strongly from the financial crisis in the first place. “The full year contraction of 1.7% in 2009 was significantly better than expected amid the still-strong economic and financial fundamentals,” says Lee at CIMB. And it is bouncing back quickly too. “We had the right policies to steer the economy out of the negative growth last year,” says Manokaran. “Timely changes in fiscal and monetary policy, and reforms introduced by the government this year, have been instrumental in leading the economy out of recession.”

Manokaran is referring to a series of measures introduced by Najib Razak, Malaysia’s prime minister, over the last year. One was to allow 100% foreign ownership in 27 industries and sectors. Perhaps more significantly, a long-standing requirement for 30% stakes in listed companies to be allocated to Bumiputras, or ethnic Malays, has been relaxed. (See more on this in the equity chapter.)

Other measures seek to attract more foreign direct investment, such as the setting up of a Special Taskforce to Facilitate Business, or Pemudah (an acronym of the Malay translation). This body has been set up to address bureaucracy in business-government dealings and has been asked to simplify FIC [Foreign Investment Committee] rules and expedite the approval process. “We hope the agency will look into the constraints affecting investment inflow,” Manokaran says. “Why are investors not coming into Malaysia now compared to the 1980s and 1990s? They are looking at ways to minimise further the bureaucracy and speed up the approvals process.”

This shift in policy was crystallised in Najib’s New Economic Model, announced in late March. Najib hopes this will transform Malaysia into a high-income economy, with developed nation status by 2020, and with a more than doubling of Malaysian per capita income to US$15,000 by the end of the decade.

Part of this program will involve a reassessment of subsidy systems and a broader revenue base through the introduction of a goods and services tax (although some of these measures already appear to have been delayed). Among other initiatives, the Employees Provident Fund, Malaysia’s key institutional investor and pension fund, is to be allowed to invest more in overseas assets; a joint venture will be formed between the government and EPF to develop a new hub in the Klang Valley; several Ministry of Finance companies will be privatised; two Petronas subsidiaries will be listed on Bursa Malaysia; and Khazanah Nasional, the investment arm of the government, will divest its 32% stake in Pos Malaysia, the postal services company, through a two stage process.

These elements will also feed into the 10^th Malaysia Plan, which will take effect from 2011 to 2015 and whose details are expected to be introduced around June. Among other things, it is expected to include a commitment to New Key Economic Areas, or NKEAs, in which investment and innovation will be encouraged, such as IT, electronics, biofuel and tourism.

Foreign analysts have welcomed the NEM. “Prime Minister Najib understands exactly what the market wants and thus knows what Malaysia needs for its long term economic survival,” said Credit Suisse analyst Danny Goh in his response to the NEM launch. “The good news is that he has not attempted to whitewash Malaysia’s problems… like the NEP (affirmative action), the high cost of doing business in Malaysia due to bureaucracy and corruption, and low-skilled and low earning workforce.” Goh thought the proposals bold but politically challenging: “PM Najib now has to use his political judgement and backbone to push this through.”

This is a real challenge but absolutely necessary: FDI numbers need to improve. Inward FDI was RM24.1 billion in 2008, and just RM5.7 billion in 2009, a 76.5% decline. That 2009 number was the lowest since 2001. It could stay tough for some time. “The carry-through impacts of the financial and economic crises on international investment flows are expected to continue,” says Lee, though he adds “overall FDI flows will likely improve over the medium term,” helped by recent liberalisation measures. “Malaysia still lags behind its regional peers in wooing FDI, not only because of the ongoing structural issues as well as perception of policy risks, but also because other economies are fast catching up.” CIMB expects RM12-14 billion in FDI inflows in 2010.

Nevertheless, Manokaran thinks that reform can help trigger a revival. “The government will face some objections in introducing some of these reforms, like the one regarding equity ownership, but if they can be implemented by the end of the year I’m sure Malaysian economic growth can be in the range of 7 to 8%.”

If they can’t, the picture will look a bit more moribund. The World Bank, in a new economic report on Malaysia called “Growth Through Innovation”, urges Malaysia to push through with reform, in particular by improving innovation capabilities (by ensuring access to talent, technology and finance), promoting competition, and concentrating efforts on promising niche products such as high technology. “The experience of countries around the world suggests that if implemented well, the right combination of policies can make a big difference in unleashing a country’s innovation potential,” said Philip Schellekens, a World Bank senior economist, at the report’s launch in April. The report applauds the reforms under the new economic model, but warns that if reform stalls, it will hurt growth and worsen the government debt to GDP ratio.

And there are already some troubling signs. “The government’s recent decision to postpone, potentially indefinitely, the introduction of GST and a new fuel subsidy regime sends the wrong signal as far as structural reform is concerned,” says Prior-Wandesforde.

Reforms are needed because of a sense that Malaysian competitiveness has been stifled – and it is increasingly widely believed that the famous New Economic Policy of the 1960s, which sought to bring about affirmative action for Bumiputras (native Malays), may inadvertently have created a sense of complacency that has left Malaysian companies uncompetitive on a world scale. The cost of doing business is also relatively high in some areas compared to peers in the region, and infrastructure could be better in areas like high speed broadband. “The main things, and the areas the government is most clearly trying to address, are a shortage of skilled manpower and bringing down the cost of doing business here,” says Manokaran.

An interesting debate is the impact that credible political opposition has had in Malaysia. Anwar Ibrahim led a coalition of opposition parties to their best ever showing in 2008, leading to the prospect of political change for the first time in the country’s modern history. Socially, Malaysia appears more troubled than it has in the recent past, perhaps because of this emergence of opposition; but economically, and in terms of reform, it appears to have been positive in spurring change. “I would think that credible opposition will ensure checks and controls,” says Manokaran. “We need this as we are introducing more changes and reforms under the 1Malaysia and NEM.” (1Malaysia is another government policy initiative.) “The government is trying to win back the people’s confidence through these reforms.”

Malaysia has traditionally spurred economic growth with the mega-projects that became famous under Mahathir Mohamed. Nobody talks about mega-projects any more, but there are still major infrastructure developments underway as a prompt to activity, such as the Iskander development region just across the straits from Singapore. The next Malaysian Plan will be closely watched to see if more such projects – perhaps a high speed rail link – will be launched.

On the fiscal and monetary side, Malaysia’s central bank, Bank Negara Malaysia, has started raising rates again. It put rates up by 0.25% in March to 2.25%, in a sign that the economy is improving. Economists were positive about the move. “This is not going to choke economic expansion,” says Manokaran. “It is still below the neutral level; it is accommodative.” Manokaran expects at least two more 25bp hikes by the end of the year.

“Both fiscal and monetary policies are aimed at providing an enabling environment for sustainable growth,” says Dr Zeti Akhtar Aziz, Governor of Bank Negara Malaysia. “Monetary policy will remain supportive of growth, while attention will continue to be focused on ensuring that the private sector, in particular SMEs, have access to financing.” She says the central bank is formulating a new financial sector blueprint to chart the development of the Malaysian financial services industry over the next decade, “so that the financial sector will reinforce transition of the Malaysian economy into a high value-added and high income economy.”

The Malaysian equity capital markets have been through a period of transition, particularly for initial public offerings (IPOs). An earlier pattern – large numbers of small deals – has been replaced by a new one: less deals, raising more money.

“In the last decade or two, we have had a boom in terms of listings for second board and Mesdaq,” says Anuar Omar, Director and Head of Corporate Finance at AmInvestment Bank. Mesdaq refers to the Malaysian Exchange of Securities Dealing and Automated Quotation, launched primarily for technology companies in 1997. “But in recent years, the market moved away from the smaller second board and Mesdaq deals toward mid- and large-cap IPOs.”

This trend can have a distorting effect on the way volume and deal numbers look. “If anyone was to look backward at the number of IPOs last year it seems that we really had a bad year because the number was so much lower: only 14 IPOs, when in our heyday we had 70 or 80,” says Anuar. “But take note that in those days IPOs were dominated by small listings that now are no longer meeting the investment appetite of retail and institutional investors.” Correspondingly, the average funds raised have risen from about RM20 to RM30 million then, to RM80 to 100 million per issue now, and 2009 featured the highest volume of IPO funds raised in the last 10 years, at RM12 billion. “As this trend will continue for IPOs, we may not see as high a number of listings as in the last decades, but IPOs will be dominated by mid- to larger capitalized companies raising more sizeable funds from the market.”

The IPO pipeline is now believed to be considerable. Market talk says that around 30 IPOs were approved by the Securities Commission last year but did not go ahead because of market conditions and are, in most cases, expected to come in the near future. Tan Sri Zarinah Anwar, chairman of the Securities Commission, says that “approvals for fund-raising through IPOs and other equity exercises rose to RM28.4 billion in 2009; a five-fold increase over the previous year.”

Commentators also estimate that after new equity guidelines came into effect in August 2009, a further 25 applications have been lodged with the authorities and are pending approvals or implementation. There is, though, “a time lag for IPOs in Malaysia compared to follow-on offerings,” says Anuar. “It can take six to nine months to roll out an IPO.” Not every mooted deal will reach the market this year – some may never come, as investors are still selective – but practitioners are hopeful of at least a doubling in the number of listings in 2010 compared to 2009, and potentially as many as 40.

Other trends suggest a positive future. “Three China-based companies preferred Malaysia as a listing destination over other regional exchanges” in 2009, Zarinah says. (Sports shoe manufacturer Xingquan International became the first to do so in July 2009, followed the next month by a sports shoe soles manufacturer, Multi Sports.)

Then there was the most notable deal of the year. “Maxis Berhad’s return to the equity market also marked Malaysia’s biggest initial public offering,” at RM11.2 billion, Zarinah says. Maxis was, though, inevitably a one-off. “I don’t think you can replicate what happened last year,” says Nor Rejina Abdul Rahim, managing director for Malaysia at Nomura Asset Management. “Maxis is not something you can come up with every year.” Dato’ Charon Wardini Mokzhani, deputy chief executive officer for corporate and investment banking at CIMB group, adds: “2010 looks like a year that will have a greater number and diversity of issuers and a wider range of deal sizes. A deal on the scale of the Maxis IPO is, however, unlikely.”

At the time of writing only one major IPO had been done in 2010, for hard drive manufacturer JCY International, and even that was downsized from around RM1 billion to RM675 million. “But the pipeline is quite strong,” says Chay Wai Leong, head of RHB Investment Bank. “There are two REIT deals coming, from Sunway City and CapitaLand; CapitaLand may be slightly over a billion [ringgit].” Other IPOs in the pipeline include two subsidiaries of Petronas, Malaysia Marine & Heavy Engineering and a petrochemical business; Masterskill Education, which runs a nursing college in Kuala Lumpur; and Shin Yang Shipping, from Sarawak.

2009 was dominated by big secondary listings, most of them driven by necessity: banks needing capital, for example. Malayan Banking (Maybank) led the way with a RM6.02 billion rights issue in April 2009, the biggest ever rights issue from Malaysia. One month later Axiata Group – the rebranded Telekom Malaysia – raised RM5.25 billion. In November, Maxis launched its record-breaking RM11.2 billion IPO, and MISC, the shipping group, raised RM5.2 billion in a rights issue. There was room for one more jumbo issue before the year was out, and Malaysian Airline System provided it with a RM2.67 billion rights issue in December.

The rebound in the market has since served investors in those secondary deals extremely well: Maybank, for example, has doubled. But from a company point of view, they were giving away a lot of equity very cheaply, and the appeal of such deals quickly tailed off for those who didn’t have to do them. “There were few sizeable equity follow-on fund raising deals towards the second half of last year,” Says Anuar. “I believe a lot more companies which were planning to embark on equity fund raising since last year or the beginning of this year will come to the market this year. Now the equity market has come back and share prices have moved up, they will look at equity fund raising again.”

He cites the example of property companies, who last year were often trading below their own net assets. “It would not have been worth it for them to undertake fund raising last year. But market conditions have improved this year and most counters are no longer trading below their desired levels. Today a lot of projects are coming up, exports and GDP growth are rising, so they know that if they raise funds today they will be able to use them to enhance their earnings.”

Another prompt for secondary activity would be if M&A activity increases, as many expect it to do. “Last year valuations were relatively low, but not all companies could raise funding for M&A because of the weak credit appetite at lenders as well as low equity prices for share swap transactions,” says Anuar. “Increasingly this year M&A can be funded by borrowing given the better credit appetite.” Listed companies will also have the option to fund their M&A, or refinance borrowings for M&A, through equity fund raising. Chay at RHB is looking at a similar trend. “There is plenty that is exciting in M&A, which could lead to more fundraising,” he says.

Also, the news that Khazanah, the investment arm of Malaysia and the closest thing the country has to a sovereign wealth fund, is to divest its 32% stake in Pos Malaysia raises the prospect of more selldowns into the market to improve trading liquidity. “Najib announced they are selling their stake in Pos Malaysia all together – not just a dilution,” Anuar says. “That’s a clear signal.”

The equity markets have experienced considerable regulatory change in the last 12 months. One example is that a previous guideline for new issues on the main market, requiring issuers to be generating at least RM30 million profit after tax for the past three to five years, has been reduced to RM20 million.

Additionally, a long-standing requirement that 30% of a new listing be allocated to Bumiputras, or ethnic Malays, has also been axed as part of a broader shift in Malaysia’s iconic New Economic Policy, an affirmative action policy dating from the 1960s. There is still a requirement that part of the public spread by offered to Bumiputras, but if they don’t take it up, it goes back into the pot; capital markets practitioners have welcomed the change. “This liberalization has helped us greatly,” Anuar says. “The new guidelines give certainty of completion of the IPO once the issuers decide to launch the public offerings.”

Apart from being easier for bookrunners, it may attract new listings from companies who would otherwise have been perturbed from listing because they knew they would have to give up partial ownership of their company under onerous conditions that may not suit them. It also means secondary offerings are possible without having to top up the percentage held by Bumiputras. “I believe a lot of people will want to go for a listing as the uncertainty whether Bumiputera investors will subscribe to their offerings, as in the past, has been removed,” says Anuar.

One troubling element of the Malaysian stock market is the apparent withdrawal of foreigners, who constitute a much lower proportion of the market than they used to. In 2008 42% of the market was held by foreigners; in 2009 it dropped to 27%, and has stayed around that level since. Most left not at the time of the financial crisis, but after the general election results of March 2008. Consequently, Malaysia’s markets were less badly hit in the financial crisis; the major local funds, like the EPF and PNB, were chiefly invested locally and didn’t sell down in the crisis.

 “Foreign participation is dependent on how our market is perceived based on a variety of socio-political and economic factors, compared with other emerging markets in this region,” says Dato’ Yusli Mohamed Yusoff, CEO of Bursa Malaysia.

 “I believe the foreigners will be back,” says Anuar. Mokhzani at CIMB adds: “We are optimistic about this recovery as recent government policy announcements ought to make the Malaysian market more attractive,” particularly the New Economic Model (see economy chapter) and renewed focus on the private sector as a driver for growth. “We believe that the market will gain ground in the coming months as investors come to recognize the significance of these transformational policies.”

Raja Teh Mainmuah, who heads Islamic markets at Bursa Malaysia, says attracting international capital is happening across the capital markets, including in the development of Bursa products. “We’re working on things that would attract global investors, like ETFs that will cover other stocks, not just Malaysian but regional,” she says. “That will make it easier for Islamic fund managers.”

Coaxing foreigners back may require greater confidence in Malaysia’s political and social environment, but in any event the improved economy is likely to help. “And now the ringgit is strengthening, the trend on foreign inflows is likely to change,” says Anuar.

BOX: What’s new at Bursa?

Bursa Malaysia endured a trying financial crisis as all exchanges did, but has rebounded dramatically since. The KLCI index gained 45% over 2009, and at the time of writing was up 59% from its April 2009 low. With activity low, and only 14 IPOs in 2009, Dato’ Yusli Mohamed Yusoff, CEO, says Bursa Malaysia “used this period for capacity building for when market recovery occurs. Our focus was on enhancing infrastructure and out ongoing efforts to enhance liquidity in the market.”

This has included merging the main and second boards into a single main market, and introducing a new ACE market. The exchange also revamped its benchmark along FTSE methodology, and introduced direct market access for equities in November. Other innovations have included the introduction of minimum bid sizes, market making guidelines for structured warrants and exchange traded funds, and the development of a range of REIT and ETF products. “For 2010, we will continue to work on product diversity, greater liquidity, enhanced quality and better efficiency in the market,” Yusli says. “We look forward to more big corporate activity such as M&A, and larger listings in Malaysia. The privatization of certain government assets may contribute towards the latter development, which could also lead to more listings.”

Another innovation has been the listing of sukuk on Bursa Malaysia, which began in August 2009 with an initial flurry of 12 listings by the end of the year, worth US$17.6 billion – already a world leader in terms of listed sukuk programmes. “The whole idea behind it is to enhance transparency and governance,” says Raja Teh Maimunah, global head of Islamic markets at Bursa. “We are the second largest bond market in the region ex-Japan after Korea, and 60% of the corporate paper is sukuk. So to strengthen the market even further, we want to ensure we provide investors with information.” Sukuk list on an exempt basis and do not trade – that is still done over the counter – but by meeting the requirements of listing, sukuk provide greater transparency and also win trust. “By coming to list you are offering yourself to be regulated,” says Raja. “It enhances your profile and it becomes easier to facilitate distribution, even though you don’t trade on the exchange. A lot of pension funds we know require sukuks to be listed – because if it’s listed, somebody else is doing the policing.”

Once that’s done, she would like to see an exchange-traded sukuk framework, “to allow retail investors access to a market that is otherwise predominantly institutional and to facilitate investors diversifying their investment portfolio.”

The chief executive officer of Malaysia’s stock exchange explains why he believes Malaysia’s markets are flourishing

 Many countries’ stock markets enjoyed a flurry of capital raising in 2009, but few saw quite such a dramatic revival as Malaysia. The country hosted the largest initial public offering in the region last year – the RM11.2 billion listing of Maxis, the telecommunications operator – and also hosted the biggest rights issue in its history, a RM6.02 billion raising for Malayan Banking (Maybank) in April. Other jumbo rights issues in the course of the year came from Axiata Group (formerly Telekom Malaysia) with a RM5.25 billion issue, then RM5.2 billion from shipping group MISC and RM2.67 billion from Malaysian Airline System.

The overall number of IPOs was down – just 14 for the year – but the volume of these deals stood out. Issues like these, says Dato’ Yusli Mohamed Yusoff, chief executive officer of Bursa Malaysia, “showed that our market was ready and liquid enough to absorb huge fund-raising exercises.” They were more important than they first appear because they had what Yusli calls “a knock-on effect on the market. Maxis added approximately RM37.5 billion into Malaysia’s market capitalization.”

From Yusli’s perspective, as head of the national stock exchange, this was most welcome after a protracted difficult period. “The financial crisis had a wide reaching impact on almost every market in the world,” Yusli says, and Malaysia was not spared. Like other markets, it fell before rising in 2009, with the KLCI benchmark starting the year at 876 points and dropped to 838 by March 2009 before finishing at 1,272, a 45% gain for the year.

Yusli says Bursa used the difficult period “for capacity building for when the market recovery occurs. Our focus was on enhancing infrastructure and our efforts to enhance liquidity in the market.”

Among other things, Malaysia implemented a new fund raising framework, which included a merger of the country’s main and second boards into a single market, and the introduction of a new market, ACE, a revamped version of the previous MESDAQ market for young and technologically-focused companies. Bursa also adopted the FTSE methodology for indices – the KLCI is now, strictly speaking, the FTSE Bursa Malaysia KLCI – and has included new criteria on free float and liquidity in its methodology. “We believe this will spur listed companies to treat both these criteria as critical elements for a vibrant market.”

Also last year, direct market access (DMA) was expanded from the derivatives market to equities, “to increase accessibility and trading efficiency.” The DMA method is accounting for a growing proportion of derivative trading – although still a minority – and Bursa hopes the system will attract a new segment of equity traders.

Other efforts to improve liquidity have included easing a requirement for 30% of stock in local companies to be held by Bumiputera, or ethnic Malays – a move with major social and political implications besides. Also, government-linked companies – including many of the country’s biggest corporate names – are being encouraged to slim their non-core holdings in stocks. Minimum bid sizes have been introduced, an OTC model has been set up for stock borrowing and lending, and market making guidelines have been launched for structured warrants and exchange traded funds (ETFs). All these measures, says Yusli, “bode well to create more liquidity and free float in the market.”

It remains to be seen, though, whether the jumbo issues that characterised 2010 will be repeated in 2009. The needs that drove them were very specific: capital needs for companies emerging from the financial crisis; the unusually high risk premium for debt securities; the need for companies to boost balance sheets and, in the case of banks, new regulatory requirements for them to do so; and, in the best circumstances, for business expansion. “In the second half of 2009, more companies were seen to be moving into the equity market for fund raising as there were clearer signs of confidence in the market from the economic crisis,” Yusli says. But 2010 has been marked by doubt about global recovery, and the fact that many of the companies that needed to bolster funds have already done so.

One more worrying sign is the level of foreign investor participation in Malaysia’s stock markets. In 2008, foreigners held 42% of the market; in 2009, 27%, and it remains around that level today. “Foreign participation is dependent on how our market is perceived based on a variety of socio-political and economic factors, compared with other emerging markets in this region,” Yusli says. He pins the outflow of foreign funds to the 2008 general election results, in which the grip on power of Malaysia’s ruling Barisan Nasional coalition, led by the UMNO party, looked weaker than at any time in its history. Malaysia has the prospect of political change for the first time and investors don’t like it; they have also not enjoyed the tension around opposition leader Anwar Ibrahim’s trial and the sense of growing racial unrest in the country.

The global financial crisis was also part of the reason for the outflow as foreign investors sought to reduce exposure to emerging markets – oddly so in some ways, since emerging market economies have vastly outperformed those in the west.

That’s a challenge that will need to be redressed for the long-term health of the market. In the meantime, Bursa has focused on product development. Malaysia offers a sophisticated range of product, from ETFs to real estate investment trusts (REITS), structured warrants to listed sukuk (the Islamic equivalent of a bond – Malaysia has the most vibrant domestic sukuk market in the world). “The focus,” says Yusli, “will be on creating awareness and promoting the existing product range whilst facilitating the listing of a wider range of structured products, primarily in the derivatives markets.”

The listing of sukuk has been encouraging: between August and December 2009 12 sukuk were listed, worth US$17.6 billion. This figure, Yusli says, leads the world for sukuk programme listings. The progress has continued in 2010, with Sime Darby’s RM4.5 billion sukuk programme listing; Yusli wants to see government-linked companies list their new and outstanding sukuk on the exchange this year too. The rationale for doing so is that it improves transparency and governance, and opens up sukuk to retail investors; people simply have more confidence in a regulated exchange than they do an over-the-counter market. They know who the regulator is and have confidence that penalties will be levied against non-compliant issuers.

Another new development has been Bursa Suq al-Sila’ (BSAS), a new commodity platform. Launched in mid-2009, it logs about RM500 million of trades per day. It started out as a platform for the trading of crude palm oil, in which Malaysia is a leading producer, but there are hopes to put more commodities on it, and to bring foreign Islamic financial institutions in to get involved. This year Bursa signed a memorandum of understanding with its equivalent body in Bahrain, the Bahrain Financial Exchange, to work out how to collaborate on a common platform for commodity murabahah transactions (an Islamic security). “This is in line with our aim to promote BSAS to the Middle East banks which have a significantly larger market in the commodity murabahah sector,” Yusli explains.

In the year ahead, investors should expect to see more ETFs and REITs listed with exposure to other markets in the region. But perhaps the real priority, as the Securities Commission points out in our accompanying roundtable, is not so much to keep bringing new products, as to make sure that people know the existing ones are already there. More than anything else, awareness will be a watchword for Bursa Malaysia in 2010.

There were interesting developments in Malaysian Islamic finance last month, where a chief executive move provided a commentary on the rising power of foreign banks in Malaysia while also raising questions about their conduct.

In February, Jamelah Jamaluddin cleared her desk as chief executive of RHB Islamic, one of Malaysia’s leading domestic Islamic banks, and joined Kuwait Finance House (Malaysia) as chief executive.

It is the second time JJ, as she is known in Kuala Lumpur, has followed this particular path. She was chief operating officer at RHB Sakura Merchant Bank until 2005, back in the days before Malaysian banks’ Islamic arms were hived off into separate entities. She then moved to KFH when the Kuwaiti group became one of three Middle Eastern institutions to be given wide-ranging licences to conduct Islamic finance in Malaysia. She rose to be deputy chief executive there before coming back to RHB, this time as chief executive of its Islamic entity, RHB Islamic. Now she’s heading back the other way.

It is striking that one of Malaysia’s most senior Islamic bankers finds it more alluring to work at a branch of a foreign bank than to lead a much bigger domestic one. Granted, KFH is not just any foreign bank: it is the second-largest Islamic institution in the world by assets, and almost certainly the one with the most dynamic international mindset, with long-standing regional ambitions in Asia (the odd recent closure of a Singapore office notwithstanding). But RHB Islamic is hardly a tiddler: it was managing M$10.9 billion ($3.2 billion) of assets by June 30 2009 and has been among the fastest-growing Islamic financial institutions in the country, with regional ambitions of its own.

In Kuala Lumpur, though, few seem particularly surprised. A Malaysian-born head of a foreign entity in Malaysia says: “If I was put in the same situation and given the choice of either leading a much larger local outfit or staying where I am in a foreign house, I would stay, because in terms of personal development the opportunities are much bigger.”

Attitudes like this must give Malaysia’s institutions, particularly Bank Negara Malaysia, food for thought. On one hand, it’s evidence of success in Malaysia’s efforts to turn itself into a truly global hub for Islamic finance, attracting leading global institutions, if not yet any actual money, to Kuala Lumpur to do business. What might not have been part of the plan is foreign institutions coming in and stealing the top talent from domestic institutions rather than bringing in their own people: Malaysia has a skill shortage in Islamic finance as it is.

Responding to a Euromoney request for comment on the appointment, KFH (Malaysia) chairman Shaheen Al Ghanem replied in an email: “It has always been the intention of KFHKuwait to engage a local talent to head its bank in Malaysia, and we have found it in Jamelah…Puan Jamelah holds the distinction for being the first woman to head a KFH bank as CEO, representing a special milestone and significant breakthrough within the KFH Group.”

There are reasons Malaysia’s regulators may be happy to see a proven home-team player stepping into the KFH Malaysia top job.

When KFH launched in Malaysia, K SalmanYounis was seconded from head office in Kuwait City to Kuala Lumpur in 2005. He was well known and accessible, driving deals, outlining plans to build the business from niche areas of expertise such as air finance into broader investment banking, corporate banking, commercial and finally retail. He was instrumental in KFH’s attempts to buy a 33% stake in RHB’s overall parent, Rashid Hussain, which came with a commitment to invest M$12 billion in turning the group into an Islamic banking powerhouse; that deal was thwarted by Malaysia’s own pension fund, the EPF, which won the bid ahead of KFH.

But did Younis push a deal too far? Officially, he was recalled to Kuwait because projects needed his involvement there, in a decision that took formal effect on June 1 2009 when he relinquished his chief executive position. But the move was sudden, with leadership temporarily passing to a deputy, Ab Jabar Ab Rahman. And it has been noticeable that since Younis’s departure, a number of the property deals he was instrumental in have fallen apart. On Christmas Eve, for example, Mah Sing Group confirmed that a deal to sell part of The Icon@Tun Razak, an office development, to Prompt Symphony for M$237.1 million had been aborted because the purchaser had failed to pay the balance, forfeiting a M$42.7 million deposit in the process.

KFH Malaysia denies having an interest in the transaction but Euromoney understands Prompt Symphony is a special purpose vehicle 80% controlled by KFH entities. Six weeks earlier a similar Prompt Symphony deal, for The Icon@Mont Kiara, also lapsed. In another instance in December, YNH Property said it had been told by KFH that it would not go ahead with a 50% purchase of another Kuala Lumpur office tower, Menara YNH.

Is it prudence in the wake of the financial crisis? Perhaps, but that doesn’t explain KFH’s darkest moment in southeast Asia to date in early 2008, when it pledged to spend S$818.4 million ($518.4 million) on GucoLand’s Goodwood Residence in Singapore, then failed to go through with the deal, although it did later buy some units in the residence. This deal, under Younis’s watch, had raised eyebrows from the outset: S$818.4 million was about four times KFH Malaysia’s paid-up capital at the time and it has never been clear if head office in Kuwait had approved the deal – or, for that matter, the grand commitment involved in the RHB bid.

Insiders suggest KFH’s aggression in property investment had become a thorny issue in Malaysia, where prudence has been a watchword ever since the country’s banking sector reformed itself after the Asian financial crisis (notably, no domestic institutions got into any significant trouble in the global version a decade later). There are also suggestions that Jamelah’s departure from KFH the first time, and the departure of Raja Teh Maimunah, a rising name in Islamic finance who left her role as KFH’s chief corporate officer and head of international business without another job to go to in July 2008, reflected unease at the bank’s investment style and extension of credit in Malaysia. Raja Teh is now the head of Islamic capital market development at Bursa Malaysia, the stock exchange.

KFH (Malaysia) chairman Shaheen Al Ghanem directed Euromoney to the firm’s previous public statements on these transactions, offering no new comment beyond a statement that “it is part of KFHMB’s banking process and governance policy to have a constant and vigorous monitoring of all banking transactions to ensure that the bank obtains optimum value from all its transactions, especially in view of the changed economic environment”.

In this context Jamelah is a proven, experienced, safe pair of hands – and local. Her first job will be to give leadership and direction to a business that does, after all, have a lot going for it: chiefly one of the biggest chequebooks anywhere in the Islamic world.

Australian Financial Review, February 2 2010

When Anwar Ibrahim walks into the Kuala Lumpur High Court today, he will at least know what to expect.

Anwar, Malaysia’s one-time deputy prime minister and now the de facto leader of the first credible opposition in Malaysia’s independent history, is facing the third incarceration of his life. The first was a 22-month detention when a student leader in the 1970s; the second a six-year stint in 1998 for sodomy (overturned in 2004) and corruption, during the administration of his one-time mentor, Mahathir Mohamed. Now, he faces another sodomy charge, and the potential of 20 years in jail. Locally the press are calling it Sodomy II, like a sequel. “They use the same script,” he tells the AFR in an interview in his Kuala Lumpur offices. “I’ll leave it to the lawyers. I don’t have any trust in the system.”

That’s no surprise. Anwar’s trial represents an enormously significant moment for Malaysia, because it could make or break the opposition movement at a time of intense racial tension on a scale the country hasn’t seen since the race riots of the 1960s. Malaysia, though a sometimes uneasy patchwork of a Muslim Malay majority and significant Chinese and Indian minorities, has for decades been amongst the most moderate and peaceful of Muslim nations. Yet in recent months it has become a place where churches are firebombed over the right for Christians to use the word Allah, and where cows’ heads are kicked around outside Hindu temples.

Some feel these forces have been inflamed by the country’s UMNO party, the leader of the ruling Barisan Nasional coalition, seeking to secure its hold on the Malay vote; Anwar calls it “desperate measures to frustrate this peaceful transition.” But at the same time Anwar’s own rise, with his multi-racial coalition securing one third of the votes and five out of 13 states in landmark elections in 2008, has become something of a catalyst for this expression of tension. “Yes, of course that is true,” he says. “You can see the press, controlled by UMNO, blaming me for causing this, for giving courage to non-Malays to express themselves. But I think the contrary: we are giving that right of expression to all. There is a new generation of Malays who are asserting themselves with greater confidence.”

Another jail term for Anwar could do one of two things. It could wreck his coalition, which despite its outstanding 2008 performance has widely been viewed as fragile: it unites a party formed by Anwar’s wife, Wan Azizah Ismail (who is still officially its president), during Anwar’s 1998 jail term, with a sometimes hard-line Islamic party and another whose key constituency is overseas Chinese. Lacking a charismatic leader to glue it together, the alliance could fail well before the next elections, due in 2013, although Anwar insists detailed contingency plans are in place among the three parties. “There is already an agreement what to do in the event – the unlikely event – I am convicted, yet again. The coalition will stay with or without Anwar.”

Alternatively, another conviction could unite opposition behind a cause and give it renewed momentum. It is also not likely to go down well overseas, where doubts over Anwar’s earlier conviction are already widespread; public figures who have already voiced their concern for him range from Al Gore to US Supreme Court Justice Sandra Day O’Connor and, right up to his death, former Indonesian president Abdurrahman Wahid.

The uncertainty is not helping Malaysia, where foreign direct investment numbers are flagging even after accounting for recession: from M$62.8 billion in 2008 to M$12.6 billion in the first nine months of 2009. “Foreign investors are asking me about Anwar and the firebombings all the time,” says one foreign banker in Kuala Lumpur who deals with major foreign investors. “If Anwar ends up back in the slammer it’s going to have major negative consequences on Malaysia. Whether or not it will mean riots on the streets I don’t know, but it will certainly harm the government.”

Anwar is an appropriate figurehead for his country’s painful change. It’s easy to forget it now, but he was once the chosen one to succeed Mahathir: he was deputy leader and finance minister through the Asian financial crisis and was trusted so implicitly he was made acting prime minister for two months in 1997 when Mahathir took a holiday. But he wanted reform in governance and institutions, and when he started linking Mahathir with improper contracts and bailouts for family members and cronies, his time in the sun came quickly and brutally to an end. His 1998 trial raised concerns worldwide; Amnesty International considered him a prisoner of conscience, and the injuries incurred in jail cause him back pain to this day.

Because Anwar’s corruption conviction was never overturned, he was banned from politics until April 2008, and took to teaching in the US. Malaysia’s then prime minister, Abdullah Badawi, timed the 2008 elections to be just one month before Anwar’s ban expired, fearing his popular voice, but it didn’t work: Anwar simply canvassed for his wife’s party, and when his ban expired she surrendered her seat and he won it in a by-election. For a time his momentum seemed unstoppable: by September 2008 he was claiming to have secured 30 parliamentary defections that would give his coalition a majority. He demanded a vote of no confidence.

But then things stalled. First, he couldn’t force that vote, and he says he couldn’t expect his converts to declare openly until the moment of truth on the parliament floor – consequently, there’s no proof that he ever had the numbers at all. “In any democratic country we would have taken over by now, because we had the numbers, but there’s no way to go about it,” he says. “In this climate of fear and repression you can’t expect people to declare openly now except for the critical moment when the motion is tabled.” By this he is referring to the string of opposition figures, including a number of state leaders, who have been comprehensively investigated by federal institutions since the election.

Momentum was further derailed when in June 2008 a new sodomy charge, from a young aide called Saiful Bukhari Azlan, appeared with a convenience of timing that many have found deeply troubling: the taint of sodomy, illegal in this Muslim country, is considered a death knell to an aspiring politician. Whether people believe the charge or not, defending it has been time-consuming and helped to take the wind out of the challenge’s sails. And many events in the build-up to the case – the team of commandos sent to arrest him when he was on his way to the police station to make a statement, the dispute over whether the prosecution should have to let the defence see evidence prior to the trial, confirmation that Saiful visited current prime minister Najib Razak’s residence days before filing his police report – seem to bode badly for him.

But while Anwar is under pressure in the court, it’s the incumbent government, and in particular the UMNO party at its heart, that is struggling, and not just with those election results. Even in a country with a largely compliant mainstream press (but a vibrant alternative media), the government and the country’s other key institutions have found themselves mired in scandal: the death of opposition political aide Teo Beng Hock, who fell from a 14^th floor window during questioning by the Malaysian Anti-Corruption Commission (MACC). There’s the murder of the Mongolian model Altantuya Shaariibuu, the mistress of Najib’s foreign policy advisor, who prosecutors claim was killed by government commandos in 2006 and whose body was destroyed by C4 explosives. There have been scandals over contracts for French submarines, jet engines that have gone missing, and a dispute over the legitimacy of a state government in Perak.

And most recently, a court case regarding the use of word Allah by non-Muslims has flared up. In December the High Court, in dealing with a long-standing dispute between the government and the Catholic Herald newspaper, ruled that the government had no power to prohibit the use of the word Allah or to make it the exclusive preserve of Muslims. Numerous acts of arson on Christian churches have followed the ruling, while the original debate has become a somewhat farcical exercise in semantics, with the government – which, incidentally, is in the middle of a major public relations tilt called One Malaysia aimed at promoting racial and religious unity – ruling that Christians in East Malaysia can use the word Allah when speaking Malay, but that those in West Malaysia cannot.

Many of Kuala Lumpur’s business community are increasingly alarmed. “You see Najib on one hand talking about One Malaysia and a multi-racial tolerant country, and on the other you see the complete opposite of that driven by the establishment,” says a banker, who like all commercial figures in this article wished not to be named for fear of damaging relationships with government. “This may sound over the top but I would describe Malaysia as almost anarchy at the moment, because all the institutions of government believe that their job in life is to restore BN back to its previous power. The judiciary believes its job is to prosecute the opposition. The police: that their mission is to prosecute the opposition. MACC, the same. The guys in power are stoking racial unrest because they believe it’s one way of supporting the Malay vote.”

Anwar – who took some strident positions on Islam himself in his youth – has sought to preach a less radical middle ground. “I have asked the world’s most renowned authorities on Islam and nobody, not one, disputes the fact that Allah can be used by anyone,” he says. “It’s been a non-issue for 1,400 years among the Muslims.” Even PAS, the Islamic party in Anwar’s coalition, normally known as the voice of those with a more traditional and inflexible view of Islam, has publicly said they have no problem with Christians using the word: the fact that the purely Islamic party is now on more moderate ground than the government has cemented a feeling that the government has been playing the race card to try to win back disgruntled Malay voters.

The government has not been blind to change and has taken some reformist measures itself. The most significant concern the New Economic Policy, the measures enacted in the 1960s – by Najib’s father – in support of the local Bumiputra (“sons of the soil”, or Malay) population. It guaranteed them, among other things, a certain proportion of civil service jobs, and a minimum share of any stock market float. While understandable in the context of its time, many, Malays included, have come to see it as a crutch that has become a hindrance, damaging competitiveness and breeding complacency. Late last year Najib began some modest repeals.

So does Anwar believe change can be effected peacefully in Malaysia? “Well for the first phase, the five states [in the March 2008 elections], it did,” Anwar says. And despite doubts about his coalition’s durability, he argues its very cross-faith existence is enormously positive. “It means that in Malaysia, if political leaders don’t continue to incite hatred and use the race card in politics, we can survive,” he says. “The problem is UMNO: they have become an obsolete party of the past.”

But Anwar is not a Mandela and will never quite be embraced in that way. For a start, there is the fact that, having started out a somewhat radical student and youth leader, he switched allegiances to Mahathir in the 1980s and made his name soaring through the ranks of the party he now dismisses as “the last refuge of scoundrels”. He argues that when he joined Mahathir in 1981 he did so because the leader was talking about reform, and that through much of the 1980s they were effective; it was when a more authoritarian style came into effect that he objected, at great personal cost. “But can I absolve myself from the entire policy, decisions, excesses? No I cannot. I have made that very clear to the people.” Did he ever engage in the money politics commonplace in UMNO at that time? “When I announced my candidature (as deputy leader) 80% of the UMNO cabinet members, all chief ministers, were with me. So I didn’t need to go beyond that. The culture on the ground, you have big fees, but nothing compared with this cash being paid [in UMNO now].”

Additionally, some accuse him of opportunism in his career, and of inconsistency: a chameleon quality (he uses the word himself), saying what the audience of the moment want to hear, which raises questions about how he would fare in office when there can be only one decision for all audiences. Some say he is disorganised too, and unable to give his closest staff a clear mandate. “He is a great politician inasmuch as his oratory skills are fantastic, and he can definitely speak to a crowd,” says one observer. “But he can’t administer and he can’t organise.” Another stresses that “what happened in the election was a vote against government, not a vote in favour of the opposition.” On top of that mainstream media is unlikely to take his side, though the advent of Twitter, Facebook and blogs have helped dramatically, and it is noticeable how much stronger his support in well-connected and tech-savvy urban areas is than in rural Malaysia.

Listening to him in English, fluent but understated and sometimes a little unclear, one wonders how the chameleon projects to the heartland.

The answer comes later that night at a rally in a community hall in the Kuala Lumpur suburb of Cheras. Here, in the local Malay language of Bahasa, the delivery is utterly different, voice playing the ranges from aggression to a whisper, arms expressively aloft, the audience by turns brought to laughter, indignation and applause.

For sure, this is a home team crowd, but it’s largely a Malay Muslim crowd, supposedly the very core of UMNO’s appeal, and they are packed 50 deep outside the hall exits, arms folded, listening intently. Some have brought their children, drooping flopped on shoulders; it is 11.45pm on a Thursday night.

He will do the same on alternate nights leading up the trial, campaigning steadily when an election could still be years away. Over noodles with his chief ministers and supporters, well past midnight, he tells the AFR about the forthcoming weekend rallies where he expects crowds far greater than the 1,000 or so who turned up tonight.

It’s no surprise he looks tired. Earlier the AFR had thanked him for his time, remarking how busy he must be. “Not busy,” he says. “Under siege.”

 Click below for a PDF of the story as it ran

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Malaysia has become one of the region’s most liquid and reliable bond markets. Partly, that’s a function of having the region’s only mature and tested Islamic sukuk market, but the ringgit debt market has also proven itself for conventional issuers – including, to a growing extent, foreign ones.

According to ThomsonReuters data, by November 19 issuers had raised M$42.1 billion in 2009 to that date, already well ahead of the M$38.82 billion in all of 2008 and with an outside chance of matching the M$ 54.94 billion of 2007.

But although the overall numbers have stayed resilient through the crisis, the market has thinned in one sense, in that it has only been highly rated names who have had access. “Up to the Asian crisis in 1997-8, you would see bonds of BBB being traded in emerging markets,” says Seohan Soo, head of debt capital markets at AmInvestment Bank. “After the Asian crisis, for bonds issued anything below single A, there are no takers. And since subprime, we have also lost the ground of the single A market.”

Soo says that in 2009 to date, financial institutions have made up 30% of new issues, and government guaranteed or AAA names 58%, with AA rated issues accounting for 10.4% – this is typically big investment holding companies like IJM and some project financing such as toll roads and power plants. Below that, there’s almost nothing: 0.9%, or M$460 million, from single A rated issues; just M$134 million, or 0.2%, for BBB and below. “The single A market was more or less obliterated after subprime,” says Soo.

It’s not just lower rated names that have stepped back. “We are seeing more high grades, more government guaranteed, more triple A: that kind of issuer,” agrees Thomas Meow, head of debt capital markets and syndicate at CIMB Investment Bank. Lower rated credits and project financiers have appeared less. “We have seen a significant slowdown in project financing, understandably, because the government has been busy tackling the economy and took some time to come out with a stimulus package,” says Meow. “This stimulus plan will take one or two years to come to the market. But this activity will come back: the Malaysian bond market has been funding project finance requirements substantially. In the past 25-30% of the money raised here has been to fund project finance – a major difference between Malaysia and any other regional bond market.”

As the crisis unwinds, aversion to lower rated credits will probably alleviate in time. “I think investors will be cautious,” says Meow. “There will be some growth in trading appetite, it’s tipping back, but I don’t expect it to change overnight.”

In order to help it return, the government set up a credit wrapping agency, Danajamin Nasional, which formally opened on June 30. Danajamin, jointly owned by Bank Negara Malaysia and the Ministry of Finance, was launched with a guarantee quota of M$15 billion to wrap paper from lower-rated local credits in order to access Danajamin’s AAA (from local agencies Ram and Marc) rating, for a fixed fee, and find buyers. Even then, the issuers must have an investment-grade rating from a recognised rating agency in Malaysia.

“Those parts of the economy, the single A issuers, are very important to Malaysia and the government has taken steps to make sure there will be an avenue for these companies to tap the bond market rather than go back to the banks,” says Meow. “I don’t think the government wants systemic risk in the banking market.”

The hope is that Danajamin will give a shot in the arm to the markets, bring back confidence and eventually help create an environment in which single A-rated credits can issue unsupported. “To me, single A is still workable,” says Soo. “When the return is marginalized by the concentration on superior credits, eventually investors should look towards well structured transactions for single A credits for better spreads. It’s a sentiment issue.”

A separate theme in the ringgit markets has been foreigners using it to raise debt. This has chiefly been a Korean phenomenon, and had its strongest expression in 2008: Export-Import Bank of Korea raised M$1 billion in five and 10-year funding in March 2008, followed by M$1 billion from Industrial Bank of Korea the following month, M$650 million for Hyundai Capital Services in May and, the same month, M$530 million for Woori Bank. (Earlier in the year Gulf Investment Corp had raised M$1 billion).

This has been much tougher in 2009, but some deals have got away, most notably a M$1 billion deal for Hana Bank in June, upsized dramatically from a minimum target amount of M$300 million. The deal was guaranteed by the Korean government – a fairly short-lived guarantee program since Korea would prove to be one of the first economies out of recession. “We got the timing perfectly right,” says Chay Wai Leong at RHB Investment bank, the sole lead. “They were the first and the last. Straight after they used it there was a pick-up in the Korean economy and banks not longer needed to use the scheme.”

Critics say that there is a limit to how far this market can ever grow, given the limits available in the swap market. There was a feeling in 2008 that no other issuers, Korean or otherwise, could have come to the market even if they had wanted to because the ability to swap back into dollars or another currency had been exhausted.

Although Korean issuers have regained their access to dollar markets, Chay feels they will recall their positive experience raising funds in Malaysia and that the market has been developed as a consequence. “They very much appreciate this alternative avenue of fund raising,” says Chay. “After its first deal Kexim tapped the market another three times. Malaysia is on the map and it will remain on the map for them because they will remember the dark days when they needed money and there was nobody answering. Malaysia was there to plug the gap.”

The corollary to foreigners coming to Malaysia is Malaysians going overseas, such as Genting building Resort World in Singapore, YTL acquiring a Macquarie REIT also listed in Singapore, and various Malaysian companies acquiring or launching projects in Indonesia. Soo hopes this will drive the domestic debt markets. “What we are hoping to see is that our market becomes a source of capital for our regional investments, not just domestically,” he says. “Our market is too small: our population is 25, 26 million people, compared to over 200 million in Indonesia. The population in Jakarta alone is higher than Malaysia.”

Perhaps that will help get the market up to the level Soo believes it should be. Generally in the region, he says, countries have a ratio of total private debt issuance to GDP of around 100%, but in Malaysia it is below 80% – or around M$600 billion compared to an M$800 billion economy. “So we have M$200 billion to grow.” 

The investor base in ringgit debt varies according to maturity: foreign funds wanting to take a view on the ringgit as a currency play congregate in shorter-dated, one to three year securities; medium term investors like fund managers are active in the three to five year space; and insurers and pension funds dominate at five to 10 years.

Retail does not yet have a significant role to play – certainly nothing like Thailand – but there are moves towards changing that. Bursa Malaysia, the stock exchange, has been pushing to get bonds, and in particular sukuk, listed on it. Petronas and Cagamas, a special purpose vehicle of the Malaysian housing mortgage corporation, have led the way, with Cagamas starting out by listing all outstanding sukuk and bonds under its five residential mortgage-backed securitizations, amounting to M$4 billion. This follows a new rule that took effect on August 3, called an exempt regime basis, allowing the listing of sukuk and bonds on debt securities on the exchange, but in a non-tradable form. “Investors want transparency, they want governance,” says Raja Teh Maimunah Raja Abdul Aziz, head of Islamic capital markets at Bursa Malaysia. “I’m pitching that one way you can offer it is to come through an exchange: then you get regulated, reporting is required, and if any issues come up the stock exchange will take them on. Retail investors would soon appreciate that issuers are offering themselves to be regulated, and the issuers will get better pricing.” She has said she would like to see a retail trading regime for sukuk.

As far as sukuk goes, the market is widely recognised as the most mature local Islamic market in the world, by a distance. As of September 2009, there were M$168 billion of outstanding sukuk, accounting for 57.7% of all outstanding corporate bonds. If anything, the relative strength of this market on a world scale is getting more pronounced as Middle Eastern economies, particularly the prolific issuers of sukuk, have flagged and in some cases experienced defaults. “Malaysia has undoubtedly been the standout market for the last 20 years,” says Soo.

BOX: KEY DEALS

Key transactions in 2009 have tended to be government-guaranteed or highly rated. An example is the M$2.5 billion deal for Pengurusan Aset Air (PAAB), led by CIMB, upsized from M$2 billion in October. This included one year, five year and 10 year pieces, all off a M$20 billion MTN programme, and rated AAA.

The background to this deal is what makes it interesting. PAAB was set up in 2006 as a wholly-owned company of the Ministry of Finance as part of an attempt to restructure the country’s water services industry. PAAB was launched to acquire all the water assets in the country owned by state government or private water operators, with the MTN program funding the purchases.

“In the past few years, al water projects in Malaysia were funded in different ways, some with bank loans, some by the state, some through the bond market,” says Meow at CIMB. “So the privatization by the state of these assets was a problem the central government needed to solve. A new financing model needed to be put in place.”

Meow adds: “On the surface you can look at it as a bond issue, but behind it is a new private financing model that came out of the process. It allowed them to come up with a more efficient cost of financing by piggybacking on the government’s ownership,” giving it a AAA rating. “It allows the government to provide a very competitive water tariff plan.”

Another significant deal was the M$5 billion, 30-year Islamic raising for 1Malaysia Development, which at the time was known as Terengganu Investment Authority (TIA). 1MDB, as TIA is now known, subsequently set up a joint venture with PetroSaudi International in order to invest in strategic projects in Malaysia and the region.

The bond, led by AmInvestment Bank, was the first ever 30-year issue from Malaysia. “If you look at the region, not many countries have a yield curve above 10 years, never mind 20,” says Seohan Soo. “Malaysia has 20-year government securities, but we did a 30-year government-guaranteed bond, well beyond benchmark government issues. These are the things that separate our market from the rest: we have arguably the longest yield curve in the region.”