CIMB has long been the pre-eminent investment banking presence in Malaysia. Year after year it sweeps the investment banking categories in our Awards for Excellence, commonly making a clean sweep at the top of the equity capital markets, debt capital markets and M&A league tables to complement the most powerful brokerage in the country.

Nazir Razak, CIMB Group’s CEO – and sometimes referred to in Kuala Lumpur circles as Malaysia’s unofficial finance minister, since his brother, the Prime Minister, is said to seek his advice – rose through investment banking. He built that business before the many mergers that turned CIMB into a full service bank, and it remains the bank’s most impressive arm.

It’s consistently on the deals that matter nationally each year: the RM14.8 billion IPO for Petronas Chemicals Group in 2010, the US$3 billion bonds and US$1.5 billion sukuk from Petronas the previous year, the RMB20 billion Islamic MTN programme for Pengurusan Air, the RM11.2 billion Maxis IPO. And it has been a leader when Malaysia’s national champions have ventured into other markets, such as on the S$1.5 billion sukuk for Khazanah Nasional and US$1.26 billion of trust certificates for 1 Malaysia. Major M&A deals in recent years have included Sin Chew Media and Nanyang Press Holdings merging with Hong Kong’s Ming Pao and the demerger of Telekom Malaysia.

But local excellence is no longer the challenge. “We have gone quite public on the fact that we want to be the top regional universal bank – meaning southeast Asia,” says Dato’ Charon Wardini Mokhzani, CIMB’s deputy CEO and the head of the corporate and investment banking businesses, who combines a smooth confidence with a magnificent Koizumi-styled shock of silver hair. “Within that, that includes also being the top regional investment bank.”

This is a much bigger ask than dominating Malaysia’s investment banking landscape, and it puts them into competition with some powerful local competitors across the region. But there are a lot of signs of progress: CIMB is among the leaders in broking in Singapore, where it has been strong ever since acquiring local broker GK Goh in 2005, and in Indonesia, where CIMB is extremely well entrenched through its ownership of CIMB Niaga, the fifth largest bank by assets in the country.

More recently, CIMB has sought to beef up in Thailand, striking a deal with Siam Industrial Credit Public Company (usually abbreviated, tremendously, as SICCO) to buy 70% of SICCO Securities in September. This broker has 13 branches across Thailand and will be built into the existing presence, CIMB Thai Bank; Charon says that combining their market shares immediately brings it into the top 15 brokers nationally, and should be a platform to build a leader. There is already strength in investment banking. “In Thailand, Bloomberg ranks us number one for IPOs this year,” Charon says. “We are getting there.”

“Clearly, it is going to take time to be in the top three in each market in all categories. But it’s something we think is achievable.”

Next up is likely to be the Philippines, where Charon confirms the bank is in discussions to take a stake in Bank of Commerce, owned by San Miguel. That wouldn’t, in itself, create a meaningful presence in investment banking, but it would give a platform to build one; additionally, it has an agreement to distribute Philippine equities and research. “There are 10 Asean countries and we are present in eight of those [the Philippines and Laos being exceptions – CIMB’s commercial arm already has an established presence in Cambodia].

Evidence is beginning to come through in significant deals, most notably in Indonesia – which, being the region’s most populous market, has the greatest potential. CIMB was, for example, appointed as an underwriter on a bond issue from Indomobil earlier this year, and was an advisor on CVC’s buyout of Matahari Department Stores in 2010. “Because we have the number five bank, we’re really able to offer a complete universal banking-type solution,” Charon says. “Because we are positioning ourselves as an Asean regional bank, we can give regional solutions to clients; it’s surprising the number of southeast Asian companies who are investing elsewhere in southeast Asia. There is a lot of interest in regional investment flows.”

Growth in these cross-border flows will clearly be crucial to CIMB’s success as a regional player. “Intra-Asian trade is a big number, and a growing number; clearly we want to be there, growing with that,” he says. As Asean moves towards a free trade zone, more cross-border trade and investment within the region should follow. “Asean as a unit has a population half the size of China, with a GDP probably bigger than India. As a region, it’s very dynamic.”

One problem with the idea of an Asean bloc (see Euromoney, September 2011) is that it doesn’t yet exist in a meaningful form: there are still different regulations from one market to another and capital does not yet move freely. But Charon tries to present this continued variance as a positive. “Because it is diverse, it is an interesting place to be in: it’s not one homogenous market,” he says. “Finance is finance. The economics which make an M&A effective, or raising capital internationally – these don’t change and can apply anywhere.

“Each country clearly has different regulations and structures, but because we are a southeast Asian bank, we have a very strong indigenous team in these markets. We don’t fly expatriates into another country and ask them to run investment banking. We use the people in the country.”

And how about the opportunity presented by other western investment banks pulling back due to problems at home? “I don’t want to sound like a vulture fund taking advantage of other people’s weaknesses, but you would imagine that as people have issues back in their core domestic markets, they would retreat to some extent from southeast Asia,” he says. “There will be opportunities for southeast Asian banks to step in.”

BOX: Badlisyah Abdul Ghani

One area that both Malaysia and CIMB have excelled in taking an early lead is Islamic finance. Malaysia has the most sophisticated industry, and enabling framework, for Islamic finance anywhere in the world; within it, CIMB is probably the name most closely associated with innovation.

The man most responsible for building CIMB’s Islamic business, particularly on the investment banking side, is Badlisyah Abdul Ghani, now the overall CEO of CIMB Islamic. He made his name being a part of innovative structuring techniques, among them the world’s first ijarah sukuk, and asset-backed deals using the musyarakah structures. Quietly spoken and lacking some of the more outgoing statesmanship that some of his peers assume, he is nevertheless known as one of the most effective and connected people in the Islamic finance industry worldwide. Beyond CIMB, he was closely involved in Bursa Malaysia’s launch of a Shariah-compliant commodity exchange, and is also closely involved in attempts to build fund flows from the Middle East to Malaysia (he is, among other things, head of corporate client solutions for the Middle East and Brunei at CIMB at a group level). He’s on the Islamic capital market consultative panel of the stock exchange and chairs the Islamic capital market committee of the Malaysian Investment Banking Association. His involvement in such a wide range of sukuk from Malaysia has helped to shape the country’s distinct approach to Islamic finance, which differs in some crucial ways from the interpretation of the Middle East; but he has always argued that differences in interpretation, rather than needing to be ironed out and standardized, should be welcomed as a spur for innovation.

All of this has helped CIMB to a position of strength in Malaysian Islamic investment banking, but the place it might really pay off is Indonesia. The opportunity here is vast. Indonesia is, like Malaysia, a Muslim nation, but has almost nine times the population. Islamic finance is far less developed in Indonesia than Malaysia, but all the same drivers that spurred it in Malaysia exist there too: a desire to invest in a way consistent with faith; growing sophistication of the investor base; and a rising wealthy middle class. Most of the necessary legislation is in place in Indonesia now, and it’s really a question of when, not if, Islamic finance becomes widespread. Through its Niaga presence, CIMB and Abdul Ghani are better placed than most to take the opportunity.

Private banking is growing as a distinct discipline within Islamic finance. Both within the Islamic world, and among international banks, the need to provide Shariah-compliant offerings to high net worth individuals is going to become steadily more important.

Partly, this is a function of demographics: the rising wealth of the Muslim world. It is hard to put precise figures for the world’s 1.6 billion Muslim population, but Cap Gemini and Bank of America Merrill Lynch reported in their most recent World Wealth Report in June that the number of high net worth individuals in the Middle East stood at 400,000, representing a 10.4% increase during 2010. Between them they had combined wealth of US$1.7 trillion at the time of the survey, up 12.5% year on year.

“The Islamic world has experienced superior growth rates in terms of wealth generation, especially during the last two years,” says Stefan Leins, thematic research analyst at Credit Suisse. He notes that the largest part of the global Muslim community is in Asia, where wealth grew at an average of 5% a year from 2000 to 2009 before leaping 15% from 2010 to 2011. “Much of the Islamic world’s new wealth has been created by the emergence of a growing middle class in large parts of Asia and the Middle East. This leads us to the assumption that wealth generation in the Islamic world is not only superior but also sustainable.”

On top of that, Islamic banks themselves are becoming more sophisticated, and clearly see high net worth advice as a vital source of revenue, particularly as more and more mass market Muslims achieve greater wealth. In Malaysia, Islamic private banking has been a discrete field of finance for years, and it continues to grow. “Moving forward you will see a lot more momentum in Islamic private banking,” says Badlisyah Abdul Ghani, CEO of CIMB Islamic in Kuala Lumpur. And it’s not just because of demographics, but because of the sense that Islamic finance – tied as it is to real, tangible assets – is increasingly seen as resilient in an economic downturn. “Arising from the recent crisis, much of the wealth that used to be managed by conventional private bankers is now coming into the hands of Islamic private banks,” he says. “Islamic banks are now forced to come up with a framework that would be able to facilitate the needs of these high net worth individuals.” Because it is perceived as being more safe? “One of the reasons is that perception,” he says. “The other is centred on pure diversification of exposures, and who manages their funds. They want to be able to spread out a bit in terms of who is managing their wealth.”

CIMB has had a distinct Islamic private banking business for several years; at Maybank, executive vice president Choong Wai Hong says that “establishing an Islamic private bank brand is something we’re exploring right now.” For him, part of the prompt is the fact that Middle Eastern money is becoming increasingly prominent in Malaysia. “Some of these customers are more discerning in what they expect,” he says.

International banks, too, see private banking as an increasingly vital part of an Islamic offering. “It is an area which is getting to be very important,” says Wasim Saifi, global head of Islamic and consumer banking at Standard Chartered. “You’ve got customers who are quite sophisticated. Shariah compliance is an important need, but on top of that they need to balance it with the commercial aspects of that proposition. Unless and until you have a Shariah compliant range of products available, your appeal is not to the entire market.” He says it has become an especially important focus for Standard Chartered in the Middle East, particularly in Saudi Arabia, Qatar, Kuwait and parts of the UAE. “These are places where having a Shariah range of products is becoming a very important plus for a private bank.”

Leins at Credit Suisse says Islamic private banking has “absolutely” emerged as a new discipline. “Many global banks that are active in private banking, such as Credit Suisse, have started to structure a whole range of private banking services in a Shariah compliant way in order to meet Islamic clients’ demands.”

At Citibank, Ahmad Shahriman Mohd Shariff, Islamic banking head in Malaysia, adds: “A separate discipline is required if one considers all the additional obligations and considerations an Islamic investor would have with regards to his wealth.” These aren’t as straightforward as one would think: for example, Shariff points to zakat, a pillar of Islam you can roughly translate as philanthropy, which has quite specific rules for calculation that must be adhered to (see box). “While in the past, these needs were met by Islamic investors privately, there is an opportunity for Islamic financial institutions to offer commercial solutions that will help Islamic investors to meet these needs.”

Clearly, the available product suite to sell to Islamic HNW investors has improved considerably over the years, and continues to do so with every new sukuk. “The most popular instruments in Islamic investing would be the sukuks, especially in the MENA region and Malaysia,” says David Pinkerton, chief investment office of Falcon Private Bank, which is owned from the Middle East. “They have become fairly liquid, and provide investors with fixed income, which is very popular among Islamic HNWIs.” It is common for bankers to insist that Shariah compliance is not a constraint but an opportunity. “Restrictions imposed by the Shariah on investments that are available for Islamic investors should not be seen as a disadvantage,” says Shariff. “The financial crisis in 2008 has shown that there is wisdom in the restrictions imposed, and that Islamic investors who followed the restrictions saw their wealth protected during the crisis.” Shariff would like to see more product development in Shariah-compliant risk management tools, and broader wealth management solutions, but in terms of investment products, that is rarely raised as a problem these days.

But not everyone agrees with that assessment. John Sandwick, a Californian who spent much of his youth living in the Gulf before becoming a Swiss private banker tasked to bring in Arabian private clients, started his own advisory business, called Islamic Wealth & Asset Management, seven years ago in Geneva. He did so partly because his clients were asking for investments that were halal, yet in fact within the private bank many of the assets in their private banking accounts were actually haram, illegal under Shariah, because they were interest-bearing, which is prohibited.

To his mind, most of the process of asset management under Islam ought to be the same as conventional: you start with a client profile, evaluating risk appetite and investment objectives; then you create an investment strategy to fit, typically in an income, balanced or growth strategy; and then you go and buy the appropriate securities. Since it’s only the last of those processes that is any different in Islam, he set about building his approach to asset management the same way, and to do that, he decided he needed a comprehensive database of Shariah-compliant securities, or at least funds. “An asset manager has to examine all the possible securities in the investable universe,” he says. “If he doesn’t, then he is driving blind, and he is not doing his job.”

The first surprise he got was to learn that no such database existed, so with the help of some graduate students in the UK, he set about building one. The next surprise was that the resulting universe was small: 850 Islamic products. And when he filtered out funds that were too small, new, opaque, illiquid, or didn’t have a suitably robust fatwa to assert their Islamic compliance, that number shrank to 150. “It’s pathetic,” he says. “There are 66,000 suitable funds in the conventional universe.” Be that as it may, 150 has proven sufficient to build the sorts of growth, balanced and income portfolios he believes should be widely available for Islamic investors, and he says they have performed exceptionally well, not just in terms of returns but the various measures of the risk involved to get them. “While there are only really 10 fixed income funds to examine, and I would much prefer there to be 2,000, it so happens that 10 does the job. It’s an awful situation to have so few Islamic funds but we have reached the point where there are enough to achieve investment goals in a professional manner.”

Sandwick’s broader objection, though, is that if nobody else really has the database that he has, then how are they conducting asset management? “If you do not have full information on your investable universe, you cannot do asset management,” he says. “People tell me they do Islamic asset management. I say: no you don’t, you do random product sales. If you don’t have the entire universe to select from, I don’t know what you’re doing but it’s not asset management.”

Sandwick’s assertion rests on the assumption that other banks have not done the same level of research that he has, but nevertheless he has a point. There is a dearth of the sort of fund-of-fund or multimanager diversified investment products that are commonplace in the conventional mainstream. What one has instead, particularly from the international banks, is a slew of structured products underpinned, at some level, by derivatives. “Derivatives are the garbage of the professional asset management universe,” he says. “The Bill and Melinda Gates Foundation manages $36 billion. Go find me a single derivative position in there. Go to Calpers; there’s a modest amount, but only when it meets specific investment objectives. Professionals don’t buy this crap. Muslims are told it’s all they’ve got. It’s shameful.” Where, he asks, are the straightforward balanced portfolios? “If I go to [an international banker in the Middle East] and say: show me your conventional US dollar balanced portfolio, he’ll reach on his shelf and get something right away,” says Sandwick. “If I say: give me the same thing – back-tested, optimized, with all your global sorting and filtering – but with fatwa, he can’t do it.”

This touches on another point: private banking is often seen as a source of innovation in Islamic finance, in order to create equivalents to conventional world securities. It is impossible to spend more than an hour at an Islamic finance conference without hearing someone call for more and faster innovation, but a counter-argument runs that the real priority should be doing the simple things right.

On top of that, the differences in Shariah interpretation, particularly between Malaysia and the Gulf, make it difficult to think of a single investment universe that applies to the whole Islamic faith. “It’s a challenge everyone faces,” says Choong at Maybank. “When customers come from the Middle East, we have to be very sensitive about how the same principles of fatwa are interpreted there and here. It’s quite tricky.”

Beyond investment, Islamic private banking is undergoing the same transition as its conventional equivalent in Asia: a shift from pure investment advice to true wealth management. “The special needs of Islamic HNW investors have progressed from finding good Shariah compliant investment opportunities, to having a comprehensive Shariah-compliant wealth management solution,” says Shariff. That includes Shariah-compliant estate planning, takaful (insurance) and zakat (see box).

Pinkerton says that beyond selection of compliance securities, this largely mirrors the conventional world. “Shariah-compliant high net worth individuals have the same basic needs as the conventional investors in terms of capital preservation and income generation.”

But here, too, there are distinct differences. Choong at Maybank points to the concept of faraid, or wealth distribution; this governs the treatment of inheritance under Muslim law. “It is quite specifically governed by Islamic laws,” he says. “How you distribute, to whom – there is no conventional option that a customer can opt for. It is very clearly defined.” Maybank has built the capability within its trustee business to deal with this Islamically, and Choong thinks this will be “one of the anchors” of an Islamic private banking offering.

Whatever form it takes, private banking is going to continue to grow within Islamic finance, simply because every relevant factor is growing: Muslim world wealth; investor sophistication; acceptance of Islamic finance; and availability of investments. There is, quite simply, no reason for it to do anything but grow.

BOX: Islamic philanthropy

The Muslim principle of zakat requires believers to give a fixed proportion of their wealth to charity, although the proportion given – and what constitutes wealth – is widely debated. Additionally, Muslims are encouraged to make voluntary contributions, or sadaqat. Consequently philanthropy is an enormously important part of Islamic wealth management.

“The pattern of giving is not much different from the conventional world, but I think there is more giving among the Islamic high net worth than the conventional, because they see other benefits over and above what they get in this world,” says Badlisyah Abdul Ghani at CIMB Islamic. “Not necessarily the volume but the number of times that they do such giving is more, and they don’t announce it.”

Shariff at Citibank Malaysia agrees. “In general, from an Islamic perspective, philanthropy should be done discreetly with no publicity.” He says Islamic investors approach philanthropy first by calculating their zakat obligations, then adding voluntary donations. “In certain countries, Islamic investors have the option of fulfilling zakat obligations either privately or through a state appointed organization,” he says. “Regardless of the option chosen, an Islamic investor would require good advice on how to calculate the amount of zakat payable, and where possible to tie payment of zakat to tax planning as well.” This, he says, is an area where Islamic financial institutions need to do more to work out how they can provide appropriate solutions to investors.

The requirement for philanthropy has also found application in the fund management world. Last year Maybank’s Islamic banking arm created a fund through which parts of the returns go to a particular Shariah-approved charity; it represented an easy and compliant way to fulfill philanthropic duties.

In 2001, Malaysia set an ambitious target for Islamic finance. Back then, Islamic banking accounted for 6% of the overall Malaysian banking system; the target was for the figure to hit 20% by the end of the decade. But Malaysia didn’t make its target. It beat it.

Today, Islamic banking is 22% of the national market and continuing to grow steadily. Malaysia has fostered the most complete and sophisticated environment for Islamic finance worldwide, with a clear agreement between government, regulator and central bank about what needs to be done to encourage it. The legal and regulatory environment is supportive, there are entrenched Islamic industries from banking to the capital markets, asset management and takaful (insurance), and today the focus is on bringing international Islamic capital into the country through the Malaysia International Islamic Finance Centre (MIFC).

The importance of this may soon become especially clear. It is often said that Islamic finance, being linked to tangible assets, came through the global financial crisis relatively unscathed, since its banks could not have been involved in complex derivatives even if they had wanted to. It may well be that Islamic finance will have to prove its worth again as Europe drags the world into another financial malaise.

“Islamic finance is insulated from the first round effects” of a crisis, Zeti Akhtar Aziz, Governor of Bank Negara Malaysia, tells Institutional Investor. “That is because it is closely linked to the real economy, has built-in checks and balances, profit sharing, and more responsible lending. But of course as the economies slow down, as financial markets get corrected, it will impact our financial institutions. That’s why it is so important to have capital buffers, risk management and sound governance practices; these are equally important for Islamic finance as conventional.”

Governor Zeti was at the heart of initiatives after the global financial crisis to examine how Islamic finance had fared, and to work out what would be needed to strengthen the system for any subsequent crash. One of the key areas was a need for inter-bank liquidity. As a consequence the International Islamic Liquidity Management Corporation was launched by the Islamic Financial Services Board in October 2010 as a vehicle to issue Shariah-compliant financial instruments so as to improve liquidity management for Islamic banks. Kuala Lumpur is the host to this institution.

At the time of writing, IILM has a chief executive and is more or less ready to start issuing securities, which are expected to come early next year. Surely nobody could have expected it would be called upon so quickly, but its success is likely to be vital if the Eurozone situation gets any worse and European banks pull back their lending further. “We saw during the crisis that liquidity became an important issue,” says Zeti. “With the internationalization of Islamic finance, cross-border flows require short-term instruments to effectively manage – not only in stressful conditions but in normal times.” Several issues are expected to be launched each year, typically around $2-3 billion apiece; shareholders in the institution are several of the Islamic world’s major central banks and the Islamic Development Bank and its investment arm.

Current travails notwithstanding, Malaysia’s focus for Islamic finance is international. The award of a so-called megabank Islamic licence is expected shortly, with the specific aim of bringing international Islamic expertise and capital into the country. And the capital markets – Malaysia already having the most vibrant and high-volume domestic sukuk market in the world – will be increasingly cross-border too. “What has been important for us is that we have become more multi-currency,” Zeti says. “We have had a Singapore dollar sukuk this year, then RMB, as well as the dollar sukuks being issued out. We want to develop Malaysia as a centre of origination of sukuks: a meeting place for those who have funds to raise and surplus funds to invest. This is where we are.”

INDONESIA

Indonesia dominated the Asian dollar capital markets this week, with a well-received $1 billion sovereign sukuk rapidly (some would say alarmingly so) followed by another $1 billion benchmark from state electricity company Perusahaan Listrik Negara (PLN).

The seven-year sukuk was priced on Tuesday morning Asia time and gave a clear demonstration of how positively Indonesia is now seen in world markets. It priced at 4% (strictly speaking this is a profit rate rather than a yield, since this is an Islamic security), the tight end of 4-4.125% guidance. It was widely agreed that the tight pricing reflected an assumption that Indonesia, rated Ba1/BB+/BB+, with a positive outlook in Fitch and S&P’s cases, will be upgraded one more notch to investment grade. It formed a sharp contrast with the 6.29% Italy paid for a Eu3 billion five-year bond on Monday – Italy is rated A2 by Moody’s.

“The good news is in the price with regards to the rating,” said one banker. “Indonesia certainly trades like an investment grade sovereign. People feel very positive about how the future looks down there. But an upgrade is not going to result in a dramatic tightening of yields again; ratings need to catch up with reality.”

Those close to the deal say it attracted a $6.5 billion order book. “4% was an excellent outcome for them considering their last deal was 8.8% in 2009,” said one. “Seven years is a respectable maturity profile. Everybody is pretty happy with that.” The choice of maturity reflects the fact that Middle East investors, who were key to the transaction, prefer shorter-dated bonds, ideally five years; since the issuer wanted funding of up to 10 years, seven was seen as a sensible compromise. Middle East investors accounted for 30% of the deal, and had been a clear target, with a roadshow that visited Riyadh, Doha, Dubai and Abu Dhabi. Indonesian investors took 12%, the rest of Asia 32%, the US8% and Europe 18%. Funds took 59% of the deal. Citi, HSBC and Standard Chartered were lead managers.

It is harder to demonstrate that the deal’s success was down to a growing conventional investor appetite for sukuk, though some believe that it was a contributory factor. “There was a strong bedrock of interest from Middle East and Asian sukuk-specific funds, but conventional players also recognised the quality of the issuer,” said one person close to the deal, who estimated that 40% of the book were conventional investors but stressed there was some guesswork in that number.

The PLN deal was a $1 billion 10-year offer which priced on Wednesday morning Asia time, led by Barclays Capital and Citi as joint bookrunners. It priced at a yield of 5.625%, the tight end of 5.625%-5.75% guidance (a coupon of 5.5% with notes reoffered at 99.054). Some in the market considered this cheap, particularly in light of the sovereign sukuk; but S&P rates it one notch below the sovereign at BB (unlike Moody’s and Fitch, who have it at Ba1 and BB+ respectively), suggesting a slightly weaker credit than the sovereign, in addition to which the PLN deal carried a longer tenor. It is the lowest coupon PLN has ever paid for a dollar bond and represents a 150 basis point spread over comparable-tenor conventional sovereign debt.

Despite its proximity to the sovereign deal – something another banker in the market described as “breathtaking arrogance in timing” – it attracted considerable interest, with $5.5 billion of orders from more than 200 accounts. Those close to the deal say it was not simply a method of mopping up excess demand from the sukuk, since the two were marketed in very different ways as reflected in PLN’s final distribution: European investors took 21% and US investors 35%, far higher than in the sukuk, while the Middle East was not a significant source of demand for PLN. Fund managers accounted for 64%, insurers and pension funds 19%, banks 7%, private banks 6%, and central banks and others 4%.

Those close to the deal say the timing was partly coincidence; a necessary revision to the documentation had only come through late on Monday New York time, and the bond was issued swiftly thereafter to take advantage of a brief window. It did, though, probably have an impact on the aftermarket performance of the sukuk, which started out trading up and dropped below par in the wake of the PLN issue (which traded up).

Structurally, the deal was interesting because it did not use a special purpose vehicle, as most Indonesian companies do and as PLN previously has. The SPV structure avoids a withholding tax charge, but PLN’s government ownership rendered that somewhat irrelevant. Ditching the SPV opened it up to a greater range of investors, according to people close to the deal.

IILM

The International Islamic Liquidity Management Corporation, a body designed to issue short term Shariah-compliant instruments to foster better liquidity management among Islamic banks, will issue its first bonds within “the first six months” of 2012, according to Dr Zeti Akhtar Aziz, Governor of Bank Negara Malaysia.

Dr Zeti was interviewed on Tuesday in Kuala Lumpur, one day before a crucial IILM board meeting that was expected to move the body closer to its first issuance. She said the meeting should approve the parameters for issuance, including allocation of assets against which the issuance will take place, and the appointment of primary dealers who will make the market. “We are very close,” she said.

In the wake of the financial crisis, many Islamic finance leaders – Zeti prominent among them – conducted a study of the industry to establish what risks it faced and what to do about them. The lack of liquidity was one of the main findings and led to the formation of the IILM in late 2010. “We saw during this crisis that liquidity became an important issue,” she said. “With the internationalization of Islamic finance, cross-border flows require short term instruments to effectively manage, not only in stressful conditions but in normal times.”

Zeti said there will be a program of issues like to be around $2 billion to $3 billion apiece, with regular issues through the year. A first issue will be smaller, “to test the system”. Issues can come in a number of currencies but are initially expected to be in dollars; the first, pilot issue, is certainly expected to be in the US currency. “They will be high quality short-term liquid instruments and will be in demand by other funds managing portfolios – even conventional,” she said.

Issuance will be from IILM itself, which is a corporation established and backed by 12 central banks (Indonesia, Iran, Kuwait, Luxembourg, Malaysia, Mauritius, Nigeria, Qatar, Saudi Arabia, Sudan, Turkey and the UAE) and two multilaterals (the Islamic Development Bank and the Islamic Corporation for the Development of the Private Sector) as shareholders. It is understood that a formal rating will soon be announced for IILM, a vital precursor to issuance and something Zeti described as “a long process”.

The need for IILM is likely to become particularly acute if world capital markets lock up in the wake of problems in Europe. “Almost the entire world uses Treasury bills: they are highly traded and can be used to manage the liquidity of any portfolio or any financial business,” she said. “For Islamic finance, there is no sovereign that issues short term paper of that nature, and therefore IILM was established. It took us two years of work.”

Other founders agree the start line is near but that there is more to be done. “We are still crossing the Ts and dotting the Is,” said Malam Sanusi Lamido Sanusi, Governor of the Central Bank of Nigeria. “There are still issues in terms of the rulings of the Shariah Council on what we can and can’t do and how it will be structured. We’re still going through the process of structuring IILM to get the kind of rating we would like to have. It will take a little time for us to be out there.”

NIGERIA

Nigeria is set to become a fixture in the Asian debt capital markets with plans for a Malaysia-domiciled benchmark sukuk and possibly a dim sum bond next year.

In an interview in Kuala Lumpur, Malam Sanusi Lamido Sanusi, Governor of the Central Bank of Nigeria, said the country had been receiving advice from HSBC and CIMB on a sukuk, although the banks had not been formally appointed onto a deal. “We would like to see if we can issue a sukuk next year,” he said, probably in the second half. “We think that anything from five to seven years should be good for an initial offering, with the amount $700 million to a billion. That gives the kind of liquidity you want, and it also fits the tenor for most of the Arab funds who are not interested in 10-year instruments” – a consideration which also affected the choice of tenor in this week’s Indonesian sukuk (see separate story).

“The European funds tend to go for longer tenors, the Arabs for shorter, but given where Europe is, it makes a lot of sense to structure something to the areas that have a lot of liquidity,” he said.

But although Middle East investors would be targeted, Sanusi said the sukuk would “most likely” be issued out of Malaysia. “The central bank of Nigeria has had a very strong relationship with Bank Negara since I became governor,” he said, partly because Nigeria had recovered from a domestic banking crisis by studying Asian responses to the financial crisis there and had decided Malaysia was the best role model. “The Malaysian Islamic finance market is obviously the most advanced at the moment in terms of product, size and innovation, and the natural place to be.”

As with many sovereign sukuks, the hope in Nigeria is that it would prompt corporate issuers to follow. “Capital markets generally work better if you have a sovereign benchmark, that’s my view.” He also said that sukuk markets appeared to show better pricing than conventional finance. “Italy is paying 7%, so if Indonesia can raise at 4.125%, that’s a reflection of the liquidity in the sukuk markets. There is increasing interest: once conventional fund managers accept sukuk it is almost a no-brainer, as a sukuk targets both conventional and Islamic investors so you’ll probably have tighter pricing.”

He said the likely projects that would underpin the sukuk would be infrastructure, and could include aviation assets.

Sanusi also said that Nigeria’s recent decision to put 5-10% of its reserves into RMB could pave the way to a dim sum bond. The shift in reserves, he said, “is a strategic decision and recognizes the fact that China has become a major trading partner for us. It recognizes the possibility of Chinese investments in infrastructure coming in to Nigeria, and opens up for me, from a central bank perspective, the possibility of coming to the RMB market for dim sum borrowing.”

He said there was a natural argument for RMB funding. “Think of it theoretically. If we agree to accept RMB in payment for oil sales to China, you immediately generate RMB cash flows. If you have long term contracts to supply crude oil to China, you could securitize those, and raise dim sum bonds; that pays for what infrastructure investments you require from China.

“You hedge the currency risk, you get finance, and come to a very liquid market where the yields are lower and the spreads tighter than you would get in Europe at this point in time.”

A wish to avoid risk-averse European investors as a source of funding appears to be driving these moves towards Asian markets. “It is extremely important for the country to look to Asia as one likely source of borrowing,” he added. “That’s why the sukuk market in Malaysia and dim sum market in Hong Kong are markets we believe Finance [the Ministry of Finance] should be looking at.”

BEA

The Bank of East Asia’s China subsidiary has issued RMB3 billion of financial bonds in China’s interbank bond market – the second tranche in a RMB5 billion program, following a RMB2 billion launch in March.

The interest rate was set at 4.81% for the two-year bonds, which provides a reflection of how market sentiment has changed through the year; the first tranche, with the same tenor, priced at 4.39%, albeit for a larger volume.

The joint lead managers on the deal were ICBC, CICC, UBS Securities and Bank of Communications, with CICC as bookrunner. They sold the bonds only to institutional investors.

It is a queasy sort of a day when Asiamoney meets Zeti Akhtar Aziz, Governor of Bank Negara Malaysia, at Washington DC’s Four Seasons Hotel in September, and not just because of the jetlag and the changeable weather. We meet during a period of miserable uncertainty in world markets: the eurozone in crisis, the US staring at a double-dip recession, and markets looking hopefully to the IMF/World Bank annual meeting to provide some direction, which they utterly fail to do.

For Zeti, the mood is not as bad as it is for some others: Malaysia is basically doing fine, and while it will clearly slow as a result of global problems, it would be a surprise if its growth rates dipped below 4% at any point in the next 12 months. But what’s striking about this meeting is that the normally reticent and softly-spoken Zeti has some unusually strong opinions about problems in the west – and how to fix them.

That’s because, having worked through the Asian financial crisis – she was rising through the Bank Negara ranks at the time and became governor in its aftermath, in May 2000 – she believes there are clear lessons about the process of recovery that the west has not yet shown much sign of taking on board.

“While we need to deal with the financial sector and bring about regulatory reform, it has to be accompanied by pro-growth policies,” Zeti says. “That is what we did in the Asian crisis. We had to do the financial and debt restructuring, but for a chance for those policies to be successful we needed to have growth.” She’s quite specific about what she means – which also stands out, in a week dominated by broad and grand statements and an absolute minimum of practical detail: she  highlights policies to support SMEs, households, access to finance, credit enhancements, infrastructure development and private sector incentives. “We had a V shaped recovery,” she says. “Many parts of the developed world, and the IMF, said we would have a lost decade. We didn’t.”

The west, she says, just hasn’t been doing what it needs to. “Only now are we seeing some of these measures being implemented in the US,” she says. “They needed to have been implemented three years ago.” She also calls for policy that is “more anticipatory rather than reactive. When we were managing the crisis in Asia we looked at what was the worst yet to come and what did we need to do to deal with it, rather than just implementing policies to prevent a collapse and thinking that was it.”

Malaysia is not a member of the innumerable groupings and federations in world finance – the G7, the G20, the G24 – instead making its presence felt more in Asean and in Islamic finance initiatives around the world. Lacking a voice on the world stage, it is perhaps not surprising that she is not a fan of the IMF, nor of representation of emerging economies within it. “The IMF has to become neutral,” she says. “This neutrality and credibility would be enhanced if there was greater representation of emerging markets in the role of the IMF and in its governance process. Crises don’t just happen in emerging markets; this is something the IMF didn’t highlight to the world until quite late.” She says while the IMF has sought to increase that representation, it has done so “in a very incremental manner.”

She goes further and doubts the leadership the IMF has shown; Asiamoney’s interview takes place directly before the formal start of the meetings, but it’s unlikely her opinion was changed by any of the statements of the following days. “The IMF doesn’t seem to have a significant role in this,” she says. “We have looked for the IMF to have a greater role in recognizing what the issues are in their surveillance, and we look for it to provide solutions to many of these problems. Their solutions have not been forthcoming.”

So how does all this affect Malaysia and Asean? “In emerging markets we are doing better [than in the west] but we are going to see moderation in our growth as well, because we are very much part of the global economy and most of us are highly open. But we are still going to see growth, and are still on a growth path.”

Across Asia, central bank governors are having to deal with shifting priorities. For much of the last year, most of them have had to fight off inflation, and have correspondingly been rising interest rates through the year. There are markets where inflation remains a challenge – Vietnam, India, China – but across most of Southeast Asia it’s all but stopped being an issue.

Take the Bank of Thailand, which has raised rates on seven separate occasions since December, reaching 3.5%. “I think we were on the right direction so far, but if you ask the question from now on, we do think the slowdown in the world economy will mollify somewhat the inflation pressure,” says Prasarn Traitvorakul, Governor. “The job is to take a proper balance, but the balance lately has tilted towards the risk of growth becoming more apparent than inflation pressure.” When the bank next meets to discuss rates, on October 19, it would now be a major surprise to see another hike.

In places like Thailand, where domestic consumption is strong and the outlook good, the global problems have arguably been helpful. “We hope that some slowdown in the world economy will lower the pressure from the supply side,” says Prasarn. (A wild card, though, is a new government policy offering to buy local rice at heavily subsidized rates; HSBC has warned that, with Thailand being the world’s biggest rice producer, this could put inflation back on the agenda in rice-importing countries.) Like many Asian nations, Thailand has sought to boost intra-regional trade’s proportion of the overall national trade balance sheet, reducing reliance on the west, and this should prove helpful. “The feeling is not too pessimistic or optimistic,” he says. “There are threats from what’s happening in the euro zone and the US, but there are also encouraging factors like regional integration in trade and financial flows.”

Zeti, in Malaysia, has been viewing the world with similar interest. From late 2010 Bank Negara raised rates four times in seven months, from 2% to 3%, and then stopped in July, “given the increased uncertainties and the significantly heightened risks to growth,” says Zeti. From her perspective, in a country with palm oil and rubber at the heart of the national economy, commodities were the most important thing to watch. “As commodity prices stabilized, which was a major factor from the supply side producing higher inflation, demand has slowed globally,” she says. “This will limit inflation, so most central banks have paused their increases in interest rates.” Official estimates of full-year growth in Malaysia are 5-6%, but it dropped to just 4% year on year in the second quarter of 2011.

Zeti says that for central bank governors in Asia, “the biggest challenge is to have price stability in an environment of sustainable growth. You have rising prices, and at the same time you also have risks to growth, and those risks have become higher because of what is happening around the world.”

One area Asia cannot escape is capital flows. In recent years foreign money has flooded into Asia, particularly Asian bonds, in search of yield backed by strong fiscal stories. But as always, when markets get really bad, capital instead is withdrawn from these supposedly riskier asset classes, despite the fact that the risks appear far bigger in the developed world. In some cases, this isn’t a judgment on risk at all, but a need to liquidate capital in order to pay down other exposures.

Indonesia is the market that has most to lose in this respect; by the end of August foreign ownership of rupiah-denominated government bonds stood at over 35%. That money has been chasing the Indonesia story: a transformed fiscal position over the course of the last decade, a growth model predicated on commodities and domestic consumption, and an apparently successful and stable democracy. But for some time, investors both local and foreign have worried: what if it all leaves again?

Rahmat Waluyanto, in the debt management office of the Ministry of Finance, says that a modest reversal has started to happen. In the space of a week in September, foreign ownership dropped from 35.4% to 33.6%. But he is at pains to point out that foreign ownership in the government bond market is still heavily net positive, at around US$5.5 billion year to date. The withdrawal, he says, “has nothing to do with domestic economic fundamentals but FX movements due to jitters caused by the worsening euro debt crisis.” Not all fixed income is fully hedged in terms of FX exposure, hence the withdrawal, he says, although in fact non-deliverable forwards on the rupiah have been moving up, not down. “There’s no reversal yet; the real money accounts still stay,” Waluyanto says. “Indonesia has the capacity to withstand,” he adds, citing relatively large foreign exchange reserves (which crossed US$100 billion for the first time earlier this year), a widening domestic investor base (including retail investors, pension funds and insurers), and a bond stabilization framework.

Indonesia has mentioned this framework before, but it’s not always been clear what’s involved. Waluyanto says there are four strategies to negate a negative impact of a sudden reversal: the debt management office will use funds from the annual budget to buy back government securities; state-owned companies will buy in; so will be Treasury Unit and Government Investment Unit of the finance ministry; and if necessary, parliament can approve the use of accumulated cash surpluses to buy government securities.

Zeti, too, notes a change in the threat of capital flows. “We are seeing very significant surges in capital outflows and reversals,” she says. “Previously it destabilized us quite significantly. But in the current environment we are seeing these flows are better intermediated by emerging economies.” In 2009, she says, Malaysia’s reserves declined by $25 to $30 billion, with a major depreciation in the currency. “But we could take it in our stride.” She says that, in contrast to the Asian financial crisis, Malaysia has more resilient financial institutions, more developed financial markets, higher reserve levels, a more flexible exchange rate, and more instruments to sterilize inflows than before. Today, around 20% of Malaysian government bonds are foreign-held.

Whatever else happens, southeast Asia is surely the only part of the world where you can still find people barracking for sovereign upgrades at a time when the rest of the world is falling apart. In the Philippines and Indonesia, expectations are high of improved ratings from international rating agencies. Both countries can provide long lists of improvements, from budget deficits to domestic market depth and government responsibility. With Turkey having been upgraded in early September, its Asean peers are not about to stop waving the flag now. Indonesia, Waluyanto points out, has credit default swaps trading considerably tighter than Turkey’s; proof, he says, that if the story is bright there, then it’s brighter still in Indonesia. “So Indonesia should now be in the investment grade category,” he says. It’s good that somewhere in an uncertain world, there are people looking up and not down.

Asian central bank governors are shifting their focus from inflation to growth in the wake of problems in the world economy.

The Bank of Thailand has raised rates on seven consecutive occasions since December, to 3.5%, in an attempt to combat inflation pressures, but that process appears to be over for the time being. “I think we were on the right direction so far, but if you ask the question from now on, we do think the slowdown in the world economy will mollify somewhat the inflation pressure,” Prasarn Trairatvorakul, Governor, told Emerging Markets. “The job is to take a proper balance, but the balance lately has tilted towards the risk of growth becoming more apparent than inflation pressure.” Bank of Thailand’s next meeting on interest rates takes place on October 19.

In some respects, the global slowdown makes life easier for Asian central bank governors, who in many cases – most notably India and Vietnam – have wrestled with limited success with inflation this year. “We hope that some slowdown in the world economy will lower the pressure from the supply side,” Prasarn said. He added that domestic consumption in Thailand remained very strong.

Zeti Akhtar Aziz, Governor of Bank Negara Malaysia, agreed that inflation had largely ceased to be a pressing issue for Asian central banks. “As commodity prices stabilized, which was a major factor from the supply side producing higher inflation, demand has slowed globally,” she said. “This will limit inflation, so most central banks have paused their increases in interest rates.” Bank Negara hiked rates in four steps from 2% to 3% from late 2010, “to normalize interest rates and adjust the degree of monetary accommodation,” but ceased in July “given the increased uncertainties and the significantly heightened risks to growth.”

Zeti said she expected emerging markets to continue to grow, but at a slower rate due to the global economy. “In emerging markets we are doing better [than the west] but we are going to see moderation in our growth,” she said. Malaysia’s economic growth was just 4% year on year in the second quarter of 2011, though Zeti has said she expects full year growth of at least 5%.

For central bank governors in Asia, “the biggest challenge is to have price stability in an environment of sustainable growth,” Zeti said. “You have rising prices, and at the same time you also have risks to growth, and those risks have become higher because of what is happening around the world.”

Prasarn noted that Thailand’s international trade had been shifting towards an intra-regional focus, and less from the USA and the eurozone, so from his perspective “the feeling is not too pessimistic or optimistic. There are threats from what’s happening in the euro zone and the US, but there are also encouraging factors like regional integration in trade and financial flows.”

Prasarn said that international investors appeared to have responded well to Thailand’s new government. “On the positive side, the winning is quite clear, rather than a political system which is split,” he said, noting the stock market had risen after the election. “Longer term it very much depends on the results: the outcome of the work produced by the government.” He did, however, appear cautious about a controversial new rice policy that pledges to buy rice at inflated rates and has pushed rice prices up globally. “That’s also our concern,” he said. “We hope that whatever the plan, it will be executed efficiently.”

Malaysia has big ambitions. In 2010 Prime Minister Najib Razak announced the Economic Transformation Programme: a vast, enterprising plan with the overall goal of turning Malaysia into a high-income fully developed nation by 2020.

Perhaps spurred by the arrival of credible opposition in Malaysia for the first time in its modern history, Najib’s reforms go further than broad macroeconomic goals. They include political and social change as well as capital market development and a revamp of corporate governance among Malaysia’s companies. The prize, in economic terms, is a targeted growth rate of 7% annually over the next 30 years, and Malaysian citizens who are four times wealthier in real terms in 2020 than they were in 1990.

[Subhead] Malaysia and world turmoil

In the short term, though, Malaysians are looking at yet another sequence of ructions in the developed world and wondering how it will affect them. The good news: Asean nations are, in the main, in far stronger fiscal positions than most other parts of the world and therefore better equipped to deal with the problems; while Malaysia doesn’t have quite the almost debt-free fiscal position of some peers, it looks dramatically healthier than any western nation you could name. The bad news: Malaysia’s still a major exporter, and can’t be completely immune from problems elsewhere.

“Malaysia is a relatively low-volatility country,” says Dato’ Lee Kok Kwan, Deputy CEO of CIMB. “During downturns it tends to perform much better [than peers] because of that lower volatility. The GDP growth rate for 2011 may be below 5%, but it’s still decent growth.” And to look on the bright side, the flagging world economy has dampened concerns that had been rising about inflation in Malaysia, fuelled by commodity price rises.

Analysts are broadly positive about Malaysia’s outlook. “We rule out a double-dip in the Malaysian economy,” says Manokaran Mottain at AmInvestment Bank. “Robust levels of domestic demand, along with ample liquidity and the government’s ETP, will provide support at the tail end of this year.” He acknowledges, though, that the unstable global economy is certainly a negative for Malaysia, hitting both overall trade and external demand. He expects a 5% growth rate to be achieved, provided there is not a very large drop in crude oil prices or major delays to ETP projects. “As a net exporter of oil, Malaysia still relies heavily on crude oil in terms of generating income for the country,” he says.

Much like Indonesia, there has certainly been no shortage of foreign capital wanting to engage with Malaysia. “We are awash with liquidity,” says Lee. “We’re at the highest level of excess liquidity ever: the central bank needs to sterilize the system.” FDI has increased, after a period of stagnation around 2009. And portfolio flows, which were negative for about three years up to the end of 2009, have become consistently positive, attracted to Malaysia’s commodities and defensive characteristics. Foreign ownership of bonds, too, continues to rise. “The fundamentals are almost zero foreign currency debt, high FX reserves, and significant surpluses in the current account and trade account. The country, structurally, is in very good shape to absorb shocks.”

Internationally, there is a similar view. “Whenever regional markets take a dip, Malaysia outperforms every time,” says Chris Oh, analyst at UBS. “Our view remains that Malaysia will still outperform, although the reality is it will go down.” The Malaysian market, he says, has long been a story underpinned by two themes. “One, it is a relatively under-owned market: foreigners who had not been in Malaysia will come to put money here. Two, on a relative basis, Malaysia has a more stable source of funding from domestic investors.”

[Subhead] Power in banking

Malaysia’s relative strength is probably most clearly illustrated in its banking sector. 14 years on from the financial crisis, it is a powerful industry, with RM1.6 trillion in assets, healthy coverage ratios and low problems with loan impairment. “If you compare the banking sector today versus 1998, the system is significantly different, and stronger,” says Lee. “Delinquencies are low, profitability is decent, structurally it is in good shape, and the reliance on foreign currency is low. 2008 was a severe, multi-standard deviation downturn, but Malaysian banks went through that crisis completely unscathed. Nearly all remained profitable.”

With this has come the development of a relatively deep and liquid capital market. The development of Malaysia’s local currency bond market in particular has been a vital prop to the growth of the financial system and broader economy. Where once Malaysian enterprises would have to seek dollar funding, and incur foreign exchange risk, now a wide range of issuers can tap ringgit funds at durations out as far as 25 or 30 years in some cases. That is a crucial support for long-term project financing, among other things, and as major institutional investors like the Employee Provident Fund continue to gain scale and sophistication, there is more and more reason to be positive about bond market strength.

This is one of the main sources of discussion today. Malaysia’s institutions are in the process of introducing their second Capital Market Masterplan, a document designed to govern the development of the markets over the next 10 years, alongside a corporate governance blueprint being launched simultaneously.

These programs are discussed in more detail in the roundtables within this report, but in essence they aspire to promote capital formation, expand the efficiency and scope of intermediation, deepen liquidity, build capacity, improve governance and help Malaysia become a more international centre. “There’s going to be a lot of work ahead of us for everyone involved,” says Tan Sri Zarinah Anwar, chair of the Securities Commission, Malaysia’s market regulator. “In the first capital market masterplan [which governed 2001-10), it was relatively easy to do because it was a very nascent market. In today’s very uncertain conditions, with so many diverse inputs coming from so many sources, we need flexible terms on how we implement the new plan.” Zarinah says that Malaysia has a “very robust infrastructure”, but notes it “needs to build a corporate governance culture: internalising the spirit and substance of corporate governance.”

[Subhead] Islamic leader

One of the mainstays of the development of Malaysia’s financial services industry and capital markets has been the evolution of Islamic finance in the country, creating what is unarguably the most sophisticated and mature market for Islamic banking anywhere in the world. While most countries are still trying to build a domestic industry, that job is clearly done in Malaysia; for the last few years, the priority has instead been to make Kuala Lumpur a hub to attract foreign capital into Islamic finance. The Malaysia International Islamic Finance Centre is the centrepiece of this initiative, and has already succeeded in attracting some of the world’s biggest name in funds management, such as Aberdeen to Nomura.

“The government has supported the market greatly, and the infrastructure and regulatory environment are already there,” says Encik Mohd Effendi Abdullah, Head of Islamic Markets at AmInvestment Bank. “It’s easy to operate in that system. The next step is, with the government having liberalized the industry, we need to attract foreign investment here into Islamic banking. The government has given several international licences.” For some time, an Islamic megabank licence has been under discussion, although meeting its onerous terms – such as US$1 billion of paid-up capital – has apparently been problematic for bidders. A licence is apparently going to be awarded in the third quarter.

The sense of going international is pervasive at Bank Negara Malaysia, the central bank, on both the conventional and the Islamic side. “The world is highly dynamic,” says Dr Zeti Akhtar Aziz, Governor. “The environment, both domestic and international, is rapidly changing. There is therefore further work to be done.” Partly, this is about product development. “As Malaysia moves up in the value chain and transitions to new areas of economic activity, new kinds of financing will be required.” She refers to urbanization, and an ageing population, as other spurs. But Zeti’s main enthusiasm these days, beyond the domestic duties she has fulfilled for more than a decade, is the sense of Malaysia’s role in a regional and world community. “Going forward, we will become even more interdependent,” she says. “Emerging economies will become more interlinked. Malaysia will be very much part of this process. In fact, our financial institutions are having great presence in other parts of the world while our own financial system will be more liberalized. We will become increasingly connected, especially with other emerging economies.” One of Bank Negara’s priorities today is positioning Malaysia’s financial system to be ready for that, and to be in front of it, in keeping with the national ambition to be a more developed economy.

Again, Islamic finance tends to underline these themes. Dr Zeti has, for example, been at the forefront of the development of the International Islamic Liquidity Management Corp (IILM), a collaborative effort between 12 central banks and two Islamic multilaterals. IILM will issue short-term multi-currency Shariah-compliant liquidity instruments in order to boost cross-border flows between financial centres, and to preserve liquidity among Islamic markets and financial institutions. Zeti personally was a spearhead in this initiative; not coincidentally, IILM’s global headquarters is in Kuala Lumpur.

Going international is not straightforward, though; while Kuala Lumpur has attracted some world-class names to set up in Islamic fund management, for example, it’s less clear that they’ve brought any money with them. With every passing year more people in the country talk about wanting internationals to commit to bringing capital in, rather than just creating an avenue for it to leave Malaysia.

Malaysia’s stock market has been in a period of innovation for several years, trying new initiatives such as launching derivatives, facilitating listed sukuk, launching real estate investment trusts and fostering an Islamic commodities exchange. It’s a significant presence: Dato’ Tajuddin Atan, CEO of Bursa Malaysia, points out that as well as the achievements in the bond market, the stock market is home to more companies than any other in the Asean region. The market needs more secondary liquidity – Atan discusses this in the roundtable elsewhere in this report – and would like a greater chunk of more government-linked companies to be listed (which is a stated ambition of Khazanah, the state entity tasked with improving the performance of those GLCs). But generally, it stands comparison with Asean peers very well.

The stock market also plays into the Islamic theme, with the vast majority of stocks (by number more than by market capitalisation, since most banks are not Islamic) being Shariah-compliant.

[Subhead] New politics

Malaysia is due a general election next year, and it will represent an interesting and potentially divisive time for the country. For most of its history Malaysia has had no credible opposition; the strong showing of Anwar Ibrahim’s coalition in the last election was a major shake-up for the country, and it is widely felt that Prime Minister Najib’s reformist efforts have in large part been prompted by the messages of that election. Najib has recognised the need to end affirmative action policies which have supported Bumiputras, or ethnic Malays, but which have arguably reduced competitiveness and ultimately caused the country to suffer. Ending these policies, while keeping the multi-racial country in some unity, is a major challenge, and the election will be something of a referendum on how he is doing. “There’s very little doubt that the Prime Minister is extremely committed to changing things, but with Malaysia it is a question of delivery and implementation. History suggests we should be cautious in that regard,” says Robert Prior-Wandesforde, head of India and South-east Asia economics at Credit Suisse.

If that test is passed, though, Malaysia otherwise exhibits long-term thinking, and not just because of Najib’s 2020 vision. A great deal of long term infrastructure is approaching the development phase in Malaysia, providing a spur to the economy if the external situation deteriorates. Between October 2010 and June 2011, six rounds of projects – 87 initiatives within 65 projects (out of 131 identified in an initial roadmap document) – were announced, expected to bring in RM170 billion in investment and 362,000 jobs, according to UBS. They are wide ranging: the first round included an Asia e-University, a six-star St Regis hotel in Kuala Lumpur, a foundry plant in the Kulim High-Tech Park, a new low-cost carrier terminal at the airport in Sepang, and a bio-oil fuel plant in Sabah, for example. Numerous others have been announced since from petroleum and gas to education, healthcare, data, technology and mass transit.

Malaysia has a long track-record of wildly ambitious plans and has not always delivered on them. For this series, a group called the Performance Management and Delivery Unit (PEMANDU) is tasked with enabling the projects. “Investors have been sceptical about the pace of ETP implementation as BN [the ruling party]’s other government initiatives in the past are perceived to have disappointed,” says Oh. “The roll-out pace suggests a greater urgency on the part of PEMANDU and the government to roll out the private sector initiatives that will help recharge the domestic economy.” Oh says, though, that investors are really waiting for the roll out of the biggest infrastructure spending projects, such as the MRT (mass rail transit), high speed rail and Klang river revitalisation. One knock-on effect of the initiatives may be warmer relationships between Singapore and Malaysia: one of the biggest projects underway in Malaysia is in Iskander, just across the strait from Singapore. As part of this project, a one-stop customs immigration and quarantine terminal should be built at each of the two land crossings between Singapore and Malaysia, which should halve the time it takes to cross the border.

Not everyone is convinced that Malaysia can do quite what Najib asks in the next 10 years. “That would be a challenging task,” says Taimur Baig, a chief economist at Deutsche Bank. “The country is endowed with rich natural resources and is unburdened by its relatively small population, but in terms of graduating to that next level where you can unambiguously call it an economic powerhouse, the jury is very much still out.” But even if it doesn’t achieve as highly as it aims, there are positive developments underway in Malaysia; at a policy and a regulatory level, many of the ambitions look like international best practice. The big question for the country will be whether those big ideas can trickle down into thorough, effective implementation.

EM: Malaysia has a stated ambition to transform itself into a high-income nation by 2020. How important, in your view, is good corporate governance to this ambition?

David Smith, ISS Governance: Hugely important. In essence, corporate governance is about ensuring the efficient allocation of capital, with well-run companies that generate value for shareholders and incomes for individuals and families receiving funding from capital markets. Where companies on a systemic basis do not add or destroy value, countries would invariably see growth rates slow if capital is not put to work effectively.

Jamie Allen, ACGA: We think it’s extremely important. I wouldn’t directly link corporate governance to high income necessarily, just as you have to be careful linking it to profits. But it’s important to improve governance in a market so investors feel more confident, and put more money in. And while it’s only one element of creating a robust financial system, over time it can certainly contribute to the real economy.

It takes time, and faith that the government is clean and well run: you need a strong sense of public governance if you are going to have good corporate governance. That’s something Malaysia needs to work on, although the regulatory system has improved. We think that having an ICAC [independent commission against corruption] in a country is critical.

Phillip Armstrong, Global Corporate Governance Forum: The ambitions of Malaysia presuppose a lot of growth from Malaysian private sector companies. A lot of the capital needed for that growth will have to be obtained from capital markets, potentially from overseas investors, and corporate governance is an aspect they will always look at: how the companies are run, the integrity of financial reporting, and the conduct of their boards of directors. It is also critical on the state-owned side: even a fully government-controlled company may still raise funds through a debt instrument from foreign markets, and again holders will look at corporate governance.

Clarence Yang, BlackRock: A balanced and appropriate CG framework is one of the key foundations required for sustainable growth. It engenders trust and confidence among investors, and can reduce the cost of capital. This in turn can increase investment from local and foreign investors, which will lead to business opportunities and job creation.

EM: Are you familiar with corporate governance standards in Malaysia, and the CG Blueprint it has launched? What are your views on the blueprint and what it aspires to achieve?

Allen: It covers most of the right areas: if you want to improve a culture of governance in a market, you’ve clearly got to focus on companies, shareholders, and on what auditors and intermediaries are doing. The fact that they recognized the importance of private enforcement as well as public enforcement is also good. It’s a positive document, it shows the Securities Commission has accepted there is an issue around the culture of corporate governance in Malaysia, and it’s clearly a step forward. Now it’s a question of socializing it and implementing it.

Yang: BlackRock participated in the panel discussion at the launch of the CG Blueprint. Overall we are supportive, as we believe the Securities Commission has taken a thoughtful and considered approach, consulting with key stakeholders and reviewing global CG reform, and evolving best practices while ensuring relevance to the Malaysian market. We applaud the SC for taking a leadership role and sincerely hope the proposed recommendations are successfully implemented.

Smith: I am familiar with the blueprint. I think that the SC has done a great job of seeking views of various market participants on the current state of corporate governance in Malaysia, synthesising those views, and integrating them into the final document. I think that there are some really great recommendations in the blueprint that I think many in the investment community would welcome.

EM: What challenges arise when initiatives like this are put into practice at a company level? How hard is it to change a company’s attitude to corporate governance, particularly at the board level?

Yang: In our experience, reforms that have involved practitioners – both companies and investors – in the consultation process tend to be implemented more effectively. Where reform is imposed, companies tend to meet the minimum possible standards with boiler plate information in their public disclosures that does not capture the spirit of the corporate governance recommendations.

A company’s attitude to corporate governance is influenced by a range of factors: ownership structure, the size of their international business and exposure to global practices, and the diversity of experience of their board members, to name but a few. For family-controlled and managed companies, receptiveness to corporate governance can improve when the younger generation move into key management positions. Moving towards higher standards does not happen overnight: often a gradual, considered approach is less disruptive.

Allen: It is very hard. It depends on what the company wants to do and want to be. If it wants to be an internationally recognised company with international branding accessing international capital markets, governance tends to be more important than for a local business – and most businesses, in most countries, tend to be local. Also Asian companies tend not to be too concerned about brands.

Why do companies need to have CG? Some do it for altruistic or philosophical reasons, but in most cases they do it because it’s in their interests. Banks, for example, have been under pressure to do a lot more in corporate governance over the last 10 years than other companies, because Bank Negara puts higher standards on to them. Smaller, local companies are not under pressure from shareholders or regulators to improve. Regulators can set rules and regulations and, by strong enforcement, get people thinking more, but if you really want to change a culture of a company it needs to be internally driven from within.

Armstrong: There are many and varied challenges. One would start with board composition: seeking to structure a board that truly represents the strategic objective of the business, with directors who are qualified to serve and have a professional understanding of the market the business operates in, and a chairman with a strong and effective relationship with the CEO and management. Particularly if you are a company seeking international expansion and funding, it is important to ensure the way you structure your board and run your business conveys an aspiration towards international standards of good governance, while at the same time recognizing there are ways businesses are run and conducted in a domestic business environment. International standards alone are not the answer: they need to be adapted to specific cultural aspects of local markets, otherwise it’s nothing more than a box-ticking exercise.

The external focus is on developing relations with the market – shareholders, and a broader range of stakeholders. As Malaysian companies become more international it’s important the board understands the local risks and challenges that face it. Boards have to make important choices.

Another challenge under the blueprint will be to demonstrate that good governance is important because it’s good business sense, not just because there’s a rule or regulation that requires it.

Smith: This is the hard part, where the rubber hits the road. There are really two issues here – how will companies take to the new corporate governance environment, and how will shareholders engage with those companies on corporate governance issues?

The SC has been very canny in highlighting that shareholders have a role to play. The code would “require institutional investors to explain how corporate governance has been adopted as an investment criteria and the measures they have taken to influence, guide and monitor investee companies”. That is a fairly wide-ranging statement, but one that has certainly put Malaysia towards the sharp-end of best practice.

Companies should now also be aware that with the increased emphasis on the role of shareholders, they too will come under perhaps greater scrutiny than previously might have been the case. But this is not necessarily something that companies should be too concerned with. Many institutional investors operating in Malaysia do have a very good reputation globally for their corporate governance engagement work. This engagement is usually out of the public spotlight (press coverage being a great fear of companies and shareholders alike), and constructive (as opposed to confrontational and activist).

Essentially, it takes two hands to clap – evolving corporate governance requires shareholders to act as owners, and company directors to act as responsible and effective stewards of companies.

EM: What patterns do you see in the way that institutional investors in Asia seek to push for shareholder rights, transparency and other governance issues?

Allen: The one standout is the EPF. Their corporate governance principles are a very good, enlightened document. But if you look at large national and state pension schemes around Asia, and ask which ones have corporate governance or proxy voting policies, there aren’t many that do. EPF is ahead of the curve, taking a thoughtful, structured approach to the whole issue. Khazanah, too, promotes good governance in the work it does in GLC restructuring. But what about the other big institutions in Malaysia? We don’t see enough of them.

Yang: Effective engagement on these issues requires patient, constructive dialogue with suggestions for reform presented as a value proposition. The use of the media, or calling a special meeting to propose a shareholder resolution, ought to be a last resort. Domestic investors and international investors with local offices will have stronger links to the key stakeholders in the market as well as a better understanding of the salient issues. Regional investor groups such as the ACGA play an invaluable role in coordinating the views of investors and promoting universal best practice.

Armstrong: With the global financial crisis, institutional investors are going to be much more engaged in the more high-growth emerging markets. It’s a very competitive market for international capital: they can invest in Malaysia, Thailand, Indonesia or elsewhere. They will be looking for good and transparent reporting – beyond what the rules require. They will want good engagement, to develop a relationship. uch more engaged in those markets, particularly Asia.

Two areas institutional investors worry about in many emerging markets are around related-party transactions and conflicts of interest. In the west we are very preoccupied with director independence; in Asia, it’s more about independence from controlling interests than from management.

Smith: I think that the push for greater rights, and for greater transparency, takes place at two levels. First, there is regulatory engagement, whereby investors pro-actively go to regulators and establish dialogue on areas where markets may fall below best practice in terms of certain protections, such as from abusive related-party transactions.  There is a growing consensus across many Asian markets about certain issues that institutional investors are looking for – poll voting, for example – and that consensus is as a result of investor engagement.

The second prong of engagement – with companies themselves, to encourage voluntary improvements to reporting and behaviour – is also one that has proved to be useful.

EM: What are the arguments for having corporate governance rules that are mandatory, versus a code in which corporate governance is self-regulatory for companies?

Armstrong: The problem with a rules-based or mandatory code system is, because of its prescriptive nature, you do it because you have no choice. It takes away the business judgement one would expect a well-run board to exercise.

A voluntary code is dependent on a culture of conformance: you have to have a culture in the country that it is a guideline to be observed, either by applying the requirement or explaining why you’re not applying it in a substantive and honest way.

Allen: Because of differences between companies, it makes sense to leave some flexibility about which bits of the system they follow. Some bits should be mandatory, like independent directors and audit, but beyond that there should be flexibility in choice. For example, we would rather companies not set up a nomination committee if it is just going to be window dressing. Setting up committees for the sake of it is not productive. In areas like number of independent directors, board composition and internal corporate governance, companies need to be given a degree of flexibility, and this is where codes and soft laws – at a level below legislation and listing rules – are useful.

The problem in Asia is that a lot of companies just want clear guidelines. The vast majority don’t want too much choice. In North Asia, for example, the view is: if something is important there should be a law or a regulation. If it’s a soft law they’re not going to take it too seriously. In southeast Asia it’s less explicitly stated, but I think companies think the same way.

Smith: There are inherent flaws to a system of corporate governance that is self-regulatory for companies. Corporate governance is about the relationship between principals and agents – we cannot expect agents to be self-regulating through sheer goodwill were we to exclude all other actors from the regulatory regime. So, a system whereby certain things are required to be disclosed, certain things are required to be discussed and explained, and where certain behaviours are fundamentally off-limits, works best. And this is, to a large extent, what we have in most markets now – the so-called ‘comply or explain’ model of corporate governance. This assumes, however, that shareholders are engaged and vigilant, and the regulators are willing to act in the face of breaches of listing rules. This is where the system runs into trouble in most regulatory regimes – not usually by design, but by the lack of action by market participants.

EM: What should be the priorities in improving corporate governance standards in Malaysia?
Yang: We believe that moving towards mandatory poll voting, eventually for all proposals; timely disclosure of detailed voting results; and the removal of restrictions on the number of corporate representatives are important standards to prioritise. This is the first step towards ensuring a fairer voting process, enhancing transparency and accountability and encouraging greater interaction with shareholders.

Armstrong: One thing any market needs to look at is enforcement capacity: the skills of departments or agencies that are tasked with supervision. To what extent are they familiar with the code of corporate governance requirements? Do they have substantive knowledge? Are they somewhat independent from the political system?

One area Malaysia has to look at is to ensure a system and an infrastructure that genuinely supports corporate governance codes: quality of directors and boards, their training, identifying independent directors.

Another level is to ensure the business media is informed on corporate governance issues, knows how to report on them, and that institutional investors play an active role in supporting an improved corporate governance environment.

Allen: The CG blueprint is good, but there is an awful lot of work that needs to be done afterwards. To implement it, they could run workshops, training programs and forums, to discuss the blueprint and why it is important. It will be a slow, incremental, long-term process. Though the regulatory system is good in Malaysia, the corporate governance culture is pretty bad. There are some specific things that can be done like having listed firms publish their audited annual results more quickly, and continuous disclosure of material events. In enforcement, there is a need to train judges: the judiciary in Malaysia is not particularly familiar with securities and companies law.

But apart from the blueprint, a bunch of other things in Malaysia have been positive: an audit oversight board; listing rules changes on shareholder approval for privatisations; and they have addressed several issues we had touched upon in our CG Watch publication.

Smith: I think that there are many positives to the Malaysian system. I think that what is lacking a little, though, is the overall culture of corporate governance. This is, unfortunately, one of the hardest things to develop. Having said that, there are some excellent people working in Malaysia right now – the SC is doing very well under a good team, Bursa has one of the best regulators in Asia in Selarany Rasiah, whilst the Minority Shareholders’ Watchdog Group has certainly contributed. So, the future’s certainly bright for Malaysia.

EM: Malaysia’s first capital market masterplan (CMP1), which guided the development of the market from 2001 to 2010, aimed to build a capital market that would meet the country’s capital and investment needs. How far did it succeed and what still needs to be done?

Dato’ Seri Johan Raslan, PwC: The first capital market masterplan built a strong foundation for the development of core market segments, including the bond market, investment management industry and the Islamic capital market. It was a holistic model for the development of an emerging capital market. Among other things, it enabled Malaysia’s elevation to advanced emerging market status in the FTSE Global Equity Index Series and also, at the end of 2010, to cross the RM2 trillion threshold for the first time ever.

However, while our total market capitalization grew at a respectable rate of 10% per annum over the last nine years, neighbouring stock markets in Indonesia and Singapore grew at 24% and 17%, respectively. Our liquidity ranking in Asia also dropped from third in 1996 to 14th in 2011. With other destinations in the Asian region increasingly attracting investor attention, we need to bounce back.

Tan Sri Azman Hashim, AmBank: The first masterplan provided a comprehensive roadmap for the orderly growth and diversification of Malaysia’s capital markets. Evidence of CMP1’s success is that by the end of 2010, 95% of the 152 recommendations the plan made had been completed. It has led to structural changes in the channels for mobilizing and intermediating savings in Malaysia, while the sources of financing have also been broadly diversified, an important ingredient in ensuring sustainable economic growth in an open economy. Deregulation and liberalization introduced under the CMP1 has also helped lower friction costs while increasing economies of scale.

On the other hand, the challenges faced during the decade were rather different. Among other things, deeper and broader markets are necessary to enable the private sector to expand its role in intermediating savings to meet the investment needs of the population, and to provide competitive funding sources to the private sector. While CMP1 has reached its targets, a newer master plan was needed (CMP2) in order to ensure the continued expansion and improvement, and to keep pace with our target of becoming a high income nation by the year 2020

Dato’ Tajuddin Atan, Chief Executive Officer of Bursa Malaysia: Our stock market is home to more companies than any other in ASEAN, our bond market is the third-largest in Asia, and our Islamic capital market is renowned as a leading voice in the world. Credit certainly has to go to the first capital market masterplan that laid the framework for this extraordinary growth.

But the economic challenges facing Malaysia in 2011 are very different from those we faced in 2001. The landscape has changed and is changing, even as we speak. The world is interlinked by trade, and capital flows are much freer. We are now seeing a rising trend in electronic trading replicated by multiple trading venues. We need scale to matter in the global context and we need to be part of an international network to participate in these capital flows. The ASEAN link platform, for instance, is a demonstration of select ASEAN markets coming together as an asset class to raise the collective visibility of the offerings on this end of the market.

What specifically would you like to see take place in the evolution of the capital market in terms of size, tenor and range of issuers?

Raslan: Over the next 10 years, apart from the CMP2, much also depends on the GTP and ETP [Government and Economic Transformation Programmes] initiatives to drive investments, which should in turn boost Malaysia’s capital market performance and draw foreign investor interest. Ultimately, the health of the capital market rests on the economy. From an investor perspective, the hallmark of any successful capital market is open, transparent and even-handed stewardship. It’s clear that this is recognized, with close to half of CMP2’s strategies being focused on governance.

Azman: There is still room for improvement in terms of size and range of issuers. Of particular importance is attracting inward investments from the regional super powers of China and India. Malaysia has had some success in attracting  MNC’s, but given its unique capability around language and capacity around infrastructure, a sharper focus on attracting Chinese and Indian investments may yield positive results.

Reductions in transaction costs, and better communications infrastructure, would further improve Malaysia’s capital markets. Another potential improvement is to simplify the tax system currently used in Malaysia. Potential investors look foremost at simplicity, consistency and clarity of the taxation legislation of a country in considering whether to invest in it.

Atan: The theme for CMP2 is growth with governance. This will capture the essence of Malaysia’s journey towards becoming a developed nation because we must do everything we can to ensure that Malaysia’s capital market doesn’t just grow, it grows with managed and mitigated risks in a well-regulated environment.

To this end, under the CMP2, the Securities Commission will begin the process of regulatory reform, streamlining the existing regulatory framework to achieve higher levels of operational efficiency, enhancing the standards for fair and ethical business practices, and strengthening internal controls around business conduct and the management of risk.

But to take full advantage of the new opportunities being created under the CMP2 and to meet the challenges of the evolving intermediation landscape, we need to build capacity and to foster a spirit of competitiveness, risk-taking and innovation.

One challenge for Malaysia, like much of Asia, is intermediating large domestic savings from the country’s population, to investments in the Malaysian economy itself, rather than offshore (often dollar-denominated) assets. How can this be done?

Yu-Tsung Chang, Standard & Poor’s: Keeping savings within local capital markets is a common challenge in many Asian countries. Progress has been made in the last few years with Asian companies raising more capital in their local currencies. This helped to insulate them from the worst effects of the liquidity squeeze during the global financial crisis.   But a lot more work can be done.

We believe that deep and liquid debt markets are a regional imperative as many countries in Asia seek to build market maturity. Fostering national credit cultures built on transparency, creditors’ rights, and independent and objective credit analysis cannot be understated; such credit cultures enable and strengthen the development of fully functioning local corporate bond markets and broader regional markets.

In Malaysia, sound and transparent regulatory and market structures have supported the rapid growth of its bond market. Modern depository, delivery, and settlement systems have facilitated the issuance, trading, and settlement of bonds in Malaysia. Independent and objective credit analysis from local credit rating agencies and major investment banks is also well established. Recent offerings such as bond pricing services, a credit bureau, and a bond guarantee organization further strengthen the market’s infrastructure.

Over the past five years, international investors have become increasingly interested in Malaysian bonds—today they own about 10% of the country’s issuance.  And during the global financial crisis, cross-border issuers continued to issue debt into Malaysia.  While there is great potential to develop the market even further, liquidity can be a constraint for international investors because corporate issue sizes are relatively small. Other concerns include the protracted process for enforcement of legal claims in the courts and the lack of a developed secondary market for fixed income securities.

Azman: Malaysia’s high savings are expected to drive the rapid growth of the investment management industry, with assets under management projected to rise from RM377.4 billion in 2010 to RM1.6 trillion in 2020. However, in order to translate these high levels of savings in promoting economic growth, the challenge remains to divert the savings from investments in offshore assets to domestic sources.

Improving the efficiency of intermediation will likely play a major role in attracting savings into financing the economic developments of this nation. The recent announcement by the Prime Minister of a review of institutional investment strategies, to ensure optimal deployment of Government Linked Investment Company (GLIC) funds, is a step in the right direction.

Atan: Malaysia is fortunate in that it is well-positioned to finance its investment needs through its large pool of accumulated domestic savings. What we need to do is to substantially increase the creation of income-generating assets to meet the needs of domestic institutional investors.

There should be a review of the system-wide effects of institutional investment strategies, particularly to ensure the optimal deployment of government-owned funds. More efficient intermediation of national savings will have far-reaching effects on accelerating capital formation, private sector participation, secondary market liquidity, risk-taking and expanding product and service diversity.

A new private pension fund framework to enable the setting up of private retirement schemes should be in place by the end of the year. This will promote greater diversity in the management of long-term savings. There are also plans to attract specialist fund managers and to promote greater diversity in investment strategies.

Expanding the number of products on the derivatives market is another development that is crucial to deepening market liquidity, improving the ability to trade across markets and to hedge risks. The strategic alliance between Bursa Malaysia Derivatives and the CME Group has already widened the distribution of Malaysian derivative products across the world: the annual notional trading value on the derivatives market is expected to grow rapidly from the RM512 billion recorded in 2010 to RM4.2 trillion in 2020, with positive spill-over effects for stock market liquidity.

Is secondary market liquidity sufficient?

Azman: The secondary market liquidity in the capital markets, particularly in equities, is somewhat low. Based on data from Bloomberg, the average daily volume in the last six months was US$297 million, compared with US$476 million for Indonesia, US$811 million for Singapore, US$966 million for Thailand and over US$6 billion for Korea.

The government is taking steps to improve trading liquidity, with Khazanah spearheading efforts to place out stakes in government-linked companies in an orderly manner. The government is encouraging the listing of government-linked large-cap companies on Bursa Malaysia, such as Petronas Chemical and Malaysia Marine and Heavy Engineering.

Atan: Market liquidity in Malaysia has remained low over the past 10 years despite efforts to enhance the trading environment. The requirement for major domestic institutions to hold large and liquid stocks on a long-term basis reduces the amount of readily-available sizeable blocks for trading. This also increases the price impact of large trades, making it more expensive to buy or sell stocks. The deepening of secondary market liquidity here requires promoting greater diversification of portfolio asset allocations by the major domestic institutions.

How have the challenges for the Malaysian capital market changed in a more globalised world – and one in which macroeconomic shocks have been frequent?

Chang: Malaysia has an open, diversified, and competitive economy, with a moderately flexible labour market, relatively developed infrastructure in the region, ample supporting industries, and a high savings rate. The government’s economic policies are generally pragmatic. Efforts to enhance transparency and corporate governance have improved Malaysia’s business environment.

However, recent global events point to an increasingly uncertain and challenging environment ahead. If the U.S. and European economies contract deeply again or their recovery is delayed, export-dependent economies with large exposure to the U.S. or Europe would feel a pronounced economic impact. In such a scenario, Malaysia could experience export-driven slowdowns either through weaker demand or lower export prices, or both. Malaysia, like several other similarly positioned countries, would benefit from greater flexibility in fiscal and monetary policies to adjust and mitigate any exogenous shocks.

Atan: In a more globalised world, we are fighting for our share of that proverbial investment dollar. Malaysia is totally cognisant of new and fast-growing emerging markets which create a much more competitive landscape. But our market initiatives include the promotion of our key strengths – both as a country and as a capital market. For example, the ETP will be a key driver for economic growth and corporate earnings.

The Malaysian market cannot be completely decoupled from global macroeconomic shocks but it does offer relative resilience in times of regional volatility. Clearly, we stand out in terms of the domestic consumption theme, commodity stocks, oil and gas plays as well as Islamic products.

What degree of integration is desirable, and realistic, among Asean nations’ capital markets?

Raslan: We must recognize that individually, our national capital markets in ASEAN countries are very small. Only together can we make any impact in a globalised world. It is imperative that ASEAN moves towards an integrated economic zone.

Chang: There’s a long way to go in terms of integration. But intra-ASEAN market movement will help promote the further development of the local capital markets, for example, by shifting issuers from G3 markets to ASEAN local currency bond markets. There’s a lot of potential for this to happen as only about 3% of ASEAN market capitalization is invested within the region.

We are deeply committed to supporting the continued growth of ASEAN’s domestic capital markets, especially in promoting stronger financial market integration. Two years ago, we introduced an ASEAN rating scale to provide a credit benchmark that allows investors to compare risk profiles within an ASEAN context. We have already assigned more than 70 ASEAN scale ratings and expect the number to grow as the capital markets deepen.

Atan: The ASEAN Economic Blueprint envisages ASEAN becoming a single market and production base with free flow of goods and services, investment, skilled labour and freer flow of capital. The ASEAN Capital Markets Forum (ACMF) supports the above blueprint through the ACMF Implementation Plan 2015.

With this as a background, the ASEAN Exchanges are working towards the promotion of ASEAN as an asset class both within ASEAN and also internationally. The aim here is to ease and promote cross-border trading as well as global access to ASEAN markets.

Country exchanges typically have geographical jurisdictions and national asset type characteristics. Hence, integration is not a target that can be achieved in a short space of time.  However, collaboration between exchanges, which is already underway, can generate greater visibility, harmonisation and efficiencies across the ASEAN markets. This will ultimately lead to greater flows into ASEAN and within ASEAN.

Malaysia has built the most sophisticated domestic Islamic finance industry in the world, including its capital markets. How will the Islamic markets develop in future?

Raslan: With our comprehensive legislative, regulatory, legal and Shariah frameworks, Malaysia was the world’s largest exchange for sukuk listings in 2010 – some US$27.7 billion.

To further promote Malaysia as a preferred destination for raising sukuk and Islamic fund management, we need to deepen the IF legal and regulatory frameworks to facilitate international flow of funds; build closer cooperation with GCC and other Asian countries’ financial communities; develop greater clarity and consistency on the interpretation of Shariah and documentation of IF products; and address talent deficiency.

Chang: Standard & Poor’s was proud to be the first major rating agency to assign ratings in the Islamic finance sector with its rating on Malaysia Sukuk Inc in 2002. We are committed to helping global investors better understand Islamic finance, broadening their potential pool of capital.

We see a bright outlook worldwide for Islamic finance on the back of steady growth and geographic diversification. Southeast Asian countries will continue to fuel the advance of Islamic finance in Asia. We expect Malaysia to still lead the global sukuk market in issuance. Malaysia has a well-established Islamic banking system, strong regulatory framework, and government support for Islamic finance.

Southeast Asian nations are braced for volatile capital flows caused by problems in developed world economies, but insist they are now strong enough to deal with them.

“We are seeing very significant surges in capital outflows and reversals,” said Dr Zeti Akhtar Aziz, Governor of Bank Negara Malaysia. “Previously it destabilized us quite significantly. But in the current environment we are seeing these flows are better intermediated by emerging economies.”

In Indonesia, Rahmat Waluyanto, in the debt management office of the Ministry of Finance, said foreign ownership of bonds had fallen from 35.4% to 33.6% in the space of the last week, but said net inflows into the government bond market stood at $5.5 billion year to date. “There is no reversal yet: the real money accounts still stay,” he said. “We have the capacity to withstand flows.”

In 2009, deleveraging by international investors led to the withdrawal of large sums from Asian markets, particularly Korea and Malaysia. “Our currency depreciated to levels we haven’t seen for a long time, and our reserves declined by 25 to 30 billion dollars,” Zeti said. “But we could take it in our stride.” Around 20% of Malaysian government bonds are foreign-held. Emerging markets generally have been heavy recipients of foreign capital since the 2008 global financial crisis, but Asian nations worry about the impact of sudden reversals during times of macroeconomic stress.

Both policymakers said their countries had specific reasons for being more resilient to capital flight. Zeti in Malaysia cited more resilient financial institutions, more developed financial markets, higher reserve levels and a more flexible exchange rate. “The central bank also has a wider number of instruments to absorb them and to sterilize some inflows so they don’t lead to the formation of asset bubbles,” she said.

Waluyanto said Indonesia was protected by its large foreign exchange reserves (which passed US$100 billion for the first time earlier this year), a widening domestic investor base, including retail investors and the growth of pension funds and insurance, and a measure called the bond stabilization framework. He said this involves strategies to anticipate negative impacts of sudden reversals, including buybacks of government securities by his office, the coordinated purchase of government securities by state-owned corporations, and using cash surpluses with the approval of parliament to buy into the market.

However Zeti said Malaysia is still not ready for full currency liberalization. Although foreign exchange in Malaysia is much liberalized since the Asian financial crisis, with no restrictions on inflows or outflows by residents and non-residents, the ringgit has not been internationalized in a way that would allow access to the currency in offshore markets. “At this stage, our assessment is that the internationalization of the ringgit should not be hastened,” she said. “The benefits must outweigh the costs. In an environment of highly volatile global financial markets, opening the ringgit offshore market could increase the risk of significant disruptions in our domestic financial markets.”

She set out the pre-conditions to internationalizing the currency: a stronger domestic foreign exchange market, with enough market players and products to promote two-way flows; capacity among domestic companies and investors to manage foreign exchange exposures; and better risk management and corporate governance practices.

Zeti said inflation had largely ceased to be a pressing issue for Asian central banks. “As commodity prices stabilized, which was a major factor from the supply side producing higher inflation, demand has slowed globally. This will limit inflation, so most central banks have paused their increases in interest rates.” Bank Negara hiked rates in four steps from 2% to 3% from late 2010, “to normalize interest rates and adjust the degree of monetary accommodation,” but ceased in July “given the increased uncertainties and the significantly heightened risks to growth.”

Zeti said she expected emerging markets to continue to grow, but at a slower rate due to the global economy. “In emerging markets we are doing better [than the west] but we are going to see moderation in our growth.” Malaysia’s economic growth was just 4% year on year in the second quarter of 2011, though Zeti has said she expects full year growth of at least 5%.

For central bank governors in Asia, “the biggest challenge is to have price stability in an environment of sustainable growth. You have rising prices, and at the same time you also have risks to growth, and those risks have become higher because of what is happening around the world.”