Islamic Capital Market Review

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Dominick Nicholson
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1 Islamic Capital Market Review Tugu Peringatan Selangor, Shah Alam by Mohammad Aminullah Basir

2 OVERVIEW The ICM has emerged as a significant area of growth and become part and parcel of the broader capital market landscape in Malaysia. This can be attributed to the fact that the ICM has increasingly been attracting two different categories of investors those who recognise ICM instruments as a viable alternative form of financing or investment, and those who are specifically inclined towards investing and utilising only products that conform to Syariah principles. The ICM is able to offer viable and competitive alternatives to conventional products and services, hence their growing popularity and acceptability as financing and investment tools. The need to effectively and efficiently mobilise Islamic banking and Takaful funds to enhance the liquidity management of these sectors has driven the development and innovation of ICM products and services. The vibrant and efficient ICM in Malaysia has encouraged the Islamic financial services industry to operate as a complete system, similar to the conventional system where the capital market provides depth and liquidity to the system. In a year that saw significant developments for the ICM, the number of listed companies that were classified as Syariah compliant increased significantly in This reflected an increased awareness among listed companies to ensure their securities were classified as Syariah compliant and consequently widen their investor base to encompass both Islamic and conventional investors. Similarly, the number of Syariah-based unit trust funds also increased significantly in 2005, indicating the importance of Syariahcompliant securities in providing the basis for growth for Islamic collective investment schemes. The appropriate Syariah-compliance framework was pivotal in influencing the development and growth of the Malaysian ICM. The Commission established the SAC in 1996 to act as a reference centre at the national level on matters pertaining to Syariah compliance for capital market products and services. The establishment of the SAC had facilitated the Commission to further promote the growth of the ICM, particularly in ensuring the compliance of ICM products and services with the Syariah principles. In this regard in 2005, the Commission engaged and consulted the SAC in formulating a Syariah framework for facilitating the issuance of Syariah-compliant REITs through the Guidelines for Islamic Real Estate Investment Trusts (Islamic REIT Guidelines), which was released in November This was an important and highly significant achievement, as Malaysia is the first jurisdiction in the global Islamic financial sector to issue such guidelines and hence set a global benchmark for the development of Islamic REITs. The release of the Guidelines on the Offering of Islamic Securities (IS Guidelines) in July 2004 facilitated the development of more innovative and sophisticated Islamic instruments that meet the requirements of both local and global investors, especially those from the Middle East. The Malaysian Islamic bond market has since witnessed for the first time, the issuance of new Islamic instruments structured using the Syariah principles of profit- and losssharing (musyarakah) and profit-sharing (mudharabah). The IS Guidelines also provided issuers with flexibility in managing their distinct financing requirements, using different financial structures and Syariah principles. Overall, Islamic bonds became the primary choice among the issuers in 2005 when the total number and size of Islamic securities approved by the Commission substantially exceeded the total number and size of conventional PDS. Given the tremendous opportunities for growth and the goal of positioning the ICM internationally as set out in the CMP, the focus in years to come would be to provide a wide range 2-18

3 of products to meet the investment, capital raising and risk management needs of market players, as well as ensure the universal acceptability of Malaysian ICM products, close the gap between the Malaysian and Middle-East approaches and subsequently tap the vast global opportunities. STATISTICAL UPDATES List of Syariah-compliant Securities The SAC list of Syariah-compliant securities (SAC List) continued to be the main source of reference for Islamic investors and fund managers. Since it was introduced in June 1997, the SAC List has been reviewed and updated regularly to keep investors informed of the Syariah status of listed securities based on the latest audited report of the companies. In 2005, two reviews were conducted on all listed companies and the results were released on 29 April 2005 and 28 October 2005 respectively. As at end-2005, 110 securities Chart 1 Number of Syariah-compliant Securities Listed on Bursa Malaysia 1, Syariah-compliant securities (LHS) Total securities (LHS) % of Syariah-compliant securities (RHS) were added to the SAC List while 19 securities were removed. In total, there were 857 Syariah-compliant securities or 85% of the total listed securities on Bursa Malaysia as compared to 787 or 83% of the total listed securities in the previous year (Chart 1). 1 The SAC started reviewing the Syariah status of companies in the pre-ipo stage in October In 2005 the Commission received 11 applications from companies to ascertain the Syariah status of their securities prior to listing. Since the introduction of the KLSI in April 1999, its components have been updated twice a year to reflect changes to the SAC List. The KLSI, which consists of all Syariahcompliant securities on the Main Board, is the benchmark for Islamic equities that tracks the performance of Syariahcompliant securities listed on Bursa Malaysia. In November 2005, Bursa Malaysia reviewed and updated the index, resulting in 15 Syariah-compliant securities being added to and 10 securities removed from the KLSI s index basket. As at end-2005, the KLSI comprised 508 Syariah-compliant securities and the market capitalisation of Syariah-compliant securities stood at over RM400 billion or more than 60% of total market capitalisation. As part of ongoing efforts to promote greater understanding of Syariah-compliant securities, the SAC provides more detailed information on the Syariah criteria and financial benchmarks for Syariah reviews of listed securities. This information is available in the biannual SAC List booklet which is accessible from the Commission s website. No. of securities Apr 04 Oct 04 Apr 05 Oct % of Syariah-approved Syariah-based Unit Trust Funds In 2005, the Commission approved 12 new Syariah-based unit trust funds, bringing the total number of such funds to 83 or 24.4% of the total 340 approved funds in the industry as at end-2005 (2004: 71 funds or 24.4% of the total industry). Of the 83 Syariah-based unit trust funds, 18 were balanced funds, 16 were bond funds, 43 were equity funds, 2 three 1 Throughout 2005, 21 Syariah-compliant companies were excluded from the list as they were either delisted or had their listing status assumed by new entities. 2 Including Syariah index funds. 2-19

4 were fixed income funds and three were money market funds (Chart 2). The number of units in circulation for Syariah-based unit trust funds also increased from billion units as at end-2004 to billion units as at end The number of accounts registered an increase of 49.8% or 212,539 accounts, with a total of 639,539 accounts as at end In terms of value, the NAV of Syariah-based unit trust funds grew by 25.6% to RM8.49 billion while the total NAV of the whole industry grew by 12.7% to RM98.49 billion (Table 1). Over a 10-year period ( ), the NAV of Syariah-based unit trust funds grew at a compounded annual growth rate (CAGR) of 26.1% while the overall industry CAGR was 8.4%. In 2005, the Commission approved a total of 126 bond issues valued at RM60.66 billion, of which 77 were Islamic bonds valued at RM43.32 billion. This represented 71.4% of total new bonds approved (Chart 3). In terms of utilisation of the proceeds of Islamic bond issues, 78.8% were for funding of new activities, 15% for refinancing existing debts and 6.2% for expenses relating to bonds issuance (Chart 4). The year 2005 saw the launch of five Islamic bond issues structured under the profit- and loss-sharing principle Table 1 Syariah-based Unit Trust Funds Number of management companies Islamic Bonds The Islamic bond market has seen exceptional growth in the past few years, reflecting its importance as an effective alternative source of financing for new businesses, and restructuring and refinancing existing debts. Islamic bond issues grew at a CAGR of 28.3% compared to a CAGR of 14.5% for total bond issues over a 10-year period from 1995 to Number of approved funds Total approved fund size (billion units) Units in circulation (billion units) Number of accounts 639, ,000 NAV of funds (RM billion) NAV of total industry % of NAV to total industry Chart 2 Category of Syariah-based Unit Trust Funds Chart 3 Total Islamic Bonds Approved 70 Islamic bonds Bond fund 19% Equity fund 51% 60 Conventional bonds Total bonds RM billion Balanced fund 22% 10 Money market fund 4% Fixed income fund 4%

5 (musyarakah) and one issue under the profit-sharing principle (mudharabah) valued at RM5.54 billion or 12.8% of the total Islamic bonds approved by the Commission. However, a significant portion of the Islamic bonds approved were structured under the deferred payment sale (bai` bithaman ajil BBA), which constituted 36.3% (RM15.7 billion) of the total Islamic bonds approved. The remaining Islamic bonds were structured under the principles of cost plus sale (murabahah), purchase order (istisna`) and leasing (ijarah) that constituted 33.5% (RM14.5 billion), 14.5% (RM6.3 billion) and 2.9% (RM1.3 billion) of the total Islamic bonds approved respectively (Chart 5). The Commission also approved 12 Cagamas bond issues 3 valued at RM2.54 billion in Five of these bond issues, valued at RM0.9 billion and formed 35.4% of the total value of Cagamas bonds approved by the Commission, were structured under the deferred payment sale (BBA). In terms of the size of bonds issued in 2005, Islamic bonds accounted for RM9.7 billion or 27.2% of the total funds raised as compared to RM9.1 billion or 32.4% of the total issued in Among the largest issues in 2005 were the RM4.8 billion istisna` bonds issued by Jimah Energy Ventures Sdn Bhd, RM3.0 billion BBA bonds issued by Syarikat Bekalan Air Selangor Sdn Bhd, RM2.5 billion musyarakah bonds issued by Musyarakah One Capital Bhd, RM2.4 billion BBA bonds issued by Projek Lebuhraya Utara Selatan Sdn Bhd and RM2.05 billion Islamic residential mortgage-backed securities (RMBS) musyarakah bonds issued by Cagamas Bhd. PRODUCT DEVELOPMENT Issuance of First Sukuk Musyarakah The local ICM witnessed a milestone with the issuance of the first sukuk musyarakah by Musyarakah One Capital Bhd, valued at RM2.5 billion. The issuing sukuk was to acquire the receivables comprising rights, title, interests and benefits to the payment obligations of the government of Malaysia to TIME System Integrators Sdn Bhd. This was pursuant to the contract and letters of award to supply teaching equipment and provide services to various schools and certain government areas, from time to time, for implementing a programme for teaching science and mathematics in English. Chart 4 Type of Utilisation of Proceeds Chart 5 Islamic Bonds Approved Based on Various Syariah Principles New activities 78.8% Bai` bithaman ajil 36.3% Murabahah 33.5% Istisna` 14.5% Expenses relating to bonds issuanse 6.2% Refinancing 15.0% Mudharabah 0.2% Musyarakah 12.6% Ijarah 2.9% 3 Excluding the Cagamas residential mortgage-backed securities (RMBS) that was issued under the ABS structure. 4 Excluding Cagamas bonds. 2-21

6 World s First Islamic Residential Mortgage-backed Securities Another landmark issue was the world s first rated Islamic residential mortgage-backed securities issued by Cagamas MBS Bhd under the profit- and loss-sharing principle (musyarakah). The instrument, called sukuk musyarakah, involved the securitisation of a pool of government staff Islamic home financing issued at RM2.05 billion. The instrument was rated AAA ID by Malaysian Rating Corporation Bhd and AAA by Rating Agency Malaysia Bhd. The securitisation of the government staff Islamic home financing reflected the government s continuous and innovative effort to broaden the local ICM by introducing new asset classes while simultaneously creating a reference yield curve for the issuance of similar long-term Islamic ABS. Issuance of First Mudharabah Islamic Bond The first domestic Islamic corporate bond structured under the Syariah principle of profit-sharing (mudharabah) valued at RM80.0 million was issued by PG Municipal Assets Bhd. This represented Malaysia s first structured transaction backed by property taxes collected by a local authority Pihak Berkuasa Tempatan Pasir Gudang. It was also the country s first issuance of Islamic securities under the mudharabah contract, as stipulated in the IS Guidelines issued in July Launch of Dow Jones-RHB Islamic Malaysia Index In line with the recommendation outlined in the CMP to further enhance the international positioning of the Malaysian ICM and seek synergistic relationships with other major ICM players, RHB Capital Bhd collaborated with Dow Jones & Co Inc in June 2005 to construct the Dow Jones-RHB Islamic Malaysia Index, a cobranded Islamic index. This heralded another milestone for the rapidly growing local ICM. The Dow Jones-RHB Islamic Malaysia Index is part of the Dow Jones Islamic Market Index series and follows the methodology of the Syariah-compliant index family. The index applies the list of Syariah-compliant securities issued by the SAC as a basis of the index component. It has been developed specifically to meet the growing demand for Syariah-compliant equity indices. Issuance of Islamic Bond by World Bank The issuance of the RM760 million IBRD ringgitdenominated Islamic bonds, known as IBRD Wawasan Bonds, was another major milestone in the development of the local ICM. The IBRD Wawasan Bonds was the first Islamic bond issue by the IBRD in any market as well as its inaugural issue in the Malaysian capital market. Another supranational that had issued Islamic bonds in Malaysia was the International Finance Corporation in REGULATORY FRAMEWORK Guidelines for Islamic Real Estate Investment Trusts In line with the objective of providing alternative forms of investment and recognising the demand for real estate investments via Syariah-compliant instruments, the Commission released the Islamic REIT Guidelines. The guidelines was introduced to facilitate the further development of new ICM products, making Malaysia the first jurisdiction in the global Islamic financial sector to issue such guidelines and hence set a global benchmark for the development of Islamic REITs. The Islamic REIT Guidelines also facilitates the creation of a new asset class for investors and allows fund managers to further diversify their investment sources and portfolios. Additionally, it provides international investors seeking Syariah-compliant instruments an opportunity to invest in Malaysian real property without the need for direct ownership of such assets. The guidelines essentially stipulates the Syariah-compliance criteria to guide management companies in their activities relating to Islamic REITs, including the types of Syariah permissible and non-permissible rental and investment activities of such funds. The Islamic REIT Guidelines should be read together with the Guidelines on Real Estate 2-22

7 Investment Trusts that was issued on 3 January For further clarification on the application of the Islamic REIT Guidelines, a set of frequently asked questions (FAQ) was released together with the guidelines both can be accessed through the Commission s website. Approval of Syariah Advisers As required under the regulatory framework governing the issuance of Islamic bonds and unit trust funds, a registered Syariah adviser must be appointed to advise on and oversee Syariah matters relating to products, documentation, structuring and investments. In order to be registered with the Commission, the Syariah adviser, whether an individual or a company, must meet certain minimum requirements. In 2005, the Commission registered nine new Syariah advisers, 15 Syariah advisers renewed their certificates for Islamic unit trust funds while the certificates for six Syariah advisers were still valid, bringing the total number of registered Syariah advisers for Syariah-based unit trust funds to 30 (2004: 32 registered Syariah advisers, 11 deregistered). SYARIAH ADVISORY COUNCIL Issues and Resolutions The SAC continued to play its role in reviewing and providing guidance on ICM matters. In 2005, the SAC held 14 5 meetings and deliberated on several Syariah issues. Some of the key SAC resolutions are provided in Table 2 while Table 3 lists the members of the SAC. INTERNATIONAL DEVELOPMENTS On the international front, the Commission was engaged by the Islamic Development Bank (IDB) to be a member of the working committee to formulate and draft the 10-year Masterplan for the Islamic Financial Services Industry, especially those relating to the ICM. This signified the IDB s recognition of the important contributions by the Commission in promoting and developing the global ICM. This recognition was also reflected in the Commission s role of chairing IOSCO s Islamic Capital Market Task Force. In profiling the Malaysian ICM at the international level, the Commission collaborated with Bursa Malaysia and LOFSA to produce the ICM Communication Pack which contains ICM information and statistics, ranging from product development and services to regulatory framework. The ICM Communication Pack was distributed to foreign delegates attending the IDB Trade Forum and IDB Investment Conference, held in conjunction with the IDB Board of Governors Meeting in Putrajaya on 23 June Additionally, as part of efforts to promote the Malaysian ICM, as well as strategically position it among the international financial community, the Commission actively participated in various international conferences, seminars and expositions held in The Commission expressed and shared views and ideas at the following events: 1st World Islamic Funds Forum, Manama, Bahrain; 2nd Annual Asian Islamic Banking and Finance Summit, Kuala Lumpur; 2nd Kuala Lumpur Islamic Finance Forum, Kuala Lumpur; Malaysia International Halal Showcase (MIHAS 2005), Kuala Lumpur; and 30th Annual Meeting of the Board of Governors of the Islamic Development Bank, Kuala Lumpur. 5 This is inclusive of the Special SAC Meetings held to review the Syariah status of companies at the pre-ipo stage. 2-23

8 Table 2 Key Resolutions by the SAC in 2005 Islamic Bonds Application of conventional lease receivables as underlying assets for the issuance of Islamic bonds The usage of name sukuk ijarah Utilisation of the proceeds of Islamic bonds Ruling on sukuk musyarakah Application of floating rate mechanism for Islamic bonds Sale and purchase of asset used for Syariah non-permissible activities. The conventional lease receivables can be used as the underlying asset as long as the lease agreements do not contain any Syariah-prohibited elements, such as interest and late charges. In addition, the activities to be undertaken by the lessees or tenants must also be Syariah compliant. This ruling over-ruled the previous SAC ruling on this matter in Any structure of Islamic bonds that are based on leasing or ijarah contract as the underlying asset to use the term sukuk ijarah for the name of the bonds. This is important to reflect the actual underlying process of issuing sukuk, which is the securitisation of ijarah contract. This is in line with the global practice where the issuances of sukuk ijarah, such as the Malaysian Global Sukuk and Pakistan Government Sukuk are based on the securitisation of ijarah contract. The proceeds obtained from the Islamic securities issue can be utilised for financing purposes provided the instruments used are Syariah compliant and the purpose of financing must also be used for Syariah permissible projects or activities. In addition, the proceeds can also be used for general business operations of conventional financial institutions as long as it does not involve any activities and instruments that are prohibited by Syariah. Musyarakah contract must have a minimum of two investors as partners in the venture. In sukuk, this condition, however, can only be fulfilled in the first stage of issuance (primary market). In the secondary market, there is no guarantee that there will be a minimum of two investors at any one time as there is a possibility of only a single investor subscribing to the whole sum of the issue. A floating rate mechanism can be applied for Islamic bonds based on BBA, murabahah and istisna`. This is made possible with the application of rebate (ibra ) element in determining the effective profit rate of Islamic bonds. The effective profit rate will be benchmarked against the movement of the market rate such as KLIBOR. Assets used for Syariah non-permissible activities (e.g. conventional banking) cannot be used as an underlying asset for the issuance of Islamic bonds. Table 3 Members of the SAC as at End-2005 Name Datuk Sheikh Ghazali Haji Abdul Rahman (Chairman) Datuk Haji Md Hashim Haji Yahaya Prof Dr Abdul Monir Yaacob Dato Hassan Haji Ahmad Dato Dr Abdul Halim Ismail Dr Mohd Daud Bakar Assoc Prof Dr Abdul Halim Muhammad Dr Mohd Ali Haji Baharum Designation Director General/Syariah Chief Justice, Department of Syariah Judiciary Malaysia Very Distinguished Academic Fellow, Ahmad Ibrahim Kulliyyah of Laws, International Islamic University Malaysia Lecturer, Syariah and Law Department, Academy of Islamic Studies, University Malaya Mufti of Penang Executive Director, BIMB Securities Sdn Bhd President/CEO, Amanie Business Solutions Sdn Bhd Lecturer, Law Faculty, Universiti Kebangsaan Malaysia Deputy President, Angkatan Koperasi Kebangsaan Malaysia Bhd 2-24

9 To further broaden and strengthen linkages with the international financial community, the Commission received visits from foreign regulatory bodies and international research organisations from various countries, such as Indonesia, Iraq, Saudi Arabia and Japan. They visited the Commission to gain information on and an insight into the Malaysian ICM and its developments. TRAINING AND EDUCATION The Commission participated in various conferences, seminars, and expositions held in 2005 to educate market participants and create greater awareness on the ICM. Some of the significant programmes that the Commission participated in 2005 were Muzakarah on Islamic Capital Market. The theme for the Muzakarah was Ke Arah Meningkatkan Penglibatan Penasihat Syariah Dalam Pasaran Modal Islam. The programme served as a platform for discourse on the current issues surrounding the ICM with specific focus on the role of Syariah advisers; the seminar on Islamic Investment and Financing Instruments Innovative Solutions for the Capital Market; the International Islamic University s Islamic Banking and Finance Discussion Series Syariah Screening Process; workshops for participants of the Capital Market Graduate Training Scheme; and a number of discussion series held with students form various local universities to provide them with information as well as generate discussions on the development of the Malaysian ICM. 2-25

Development of the Islamic Capital Market

Development of the Islamic Capital Market Members of the Syariah Advisory Council Left to Right: Y Bhg Dato Dr Abdul Halim Ismail, Prof Madya Dr Mohd Daud Bakar, Dr Mohd Ali Haji Baharom, Y Bhg Datuk Md