Ahead of the curve: Malaysia’s leadership role in the growth of Islamic finance
A growth story with a difference
In 1990 Shell MDS, a Malaysian entity of global oil-and-gas-giant Royal Dutch Shell, tapped the capital markets for a debt issuance in the amount of RM (Malaysian Ringgit) 125 million, equivalent to about US$33 million. This relatively modest offering did not generate much notice at the time, but it turned out to be a landmark deal.
The offering was structured as “sukuk” – a capital markets instrument compliant with the principles and requirements of Islamic Shariah law – and represented the first time that a foreign-owned, non-Islamic corporation had chosen to access the capital marketplace with such an instrument. Says Dr. Zeti Akhtar Aziz, governor of Bank Negara Malaysia, the country’s central bank: “It is significant that the first issuer to raise capital via sukuk from our market was a foreign institution. Shell has access to virtually any capital market anywhere in the world, but they looked at the structure of this instrument and the tenor of this market, and found it attractive.”
In effect the Shell MDS offering bore witness to the meeting of two wildly dissimilar worlds: the sprawling, chaotic and profit-hungry commercial infrastructure of the global financial economy on the one hand; and on the other, the faith-inspired code of financial dealings for the “ummah” – the community of those who practice the Islamic faith – developed and promulgated some 1400 years ago in the teachings and revelations of the Prophet Mohammed.
As unlikely as that convergence may seem, from that comparatively modest sum of $33 million in 1990 has emerged a global sukuk market with an estimated value of over $100 billion by the end of 2008. The sukuk market itself is only one component of what is now an established, diversified market for Islamic finance, a market that covers a full range of financial products, services and solutions from banking to asset management, insurance, and a broad, sophisticated variety of capital market instruments covering the gamut from debt to equity, leasing, structured finance, real estate and even derivative securities. This market in terms of total assets volume is worth over $750 billion today and is expected to grow to over $1 trillion by 2010 based on present-day growth rates.
Not just words, but action
And from that first sukuk offering in 1990, Malaysia has been at the very forefront of Islamic finance. Malaysia’s story is a testament to the possibilities that exist when visionary leaders and practitioners from both the public and the private sectors work together in building a durable, competitive infrastructure.
“We have always been concerned to ensure, not just that Islamic finance is practiced but that it is practiced correctly,” says Dr. Zeti of Bank Negara Malaysia. “This means embracing the principles of Islamic finance in their entirety, in full Shariah compliance. All financial activities must have a real underlying economic activity – this is how you avoid the excessive uncertainty (“gharar”) that results from overleveraged speculation from pursuing activities that do not have an underlying financial value.” The requirement to avoid gharar is one of the fundamental pillars of Islamic finance, along with the prohibition of “riba” (a word most often interpreted as “interest” and a source of much focus and debate among Shariah advisors in evaluating and ruling on the permissibility of different financing structures).
This identification with underlying sources of real economic value has become an increasingly attractive feature as of late: in that Islamic financial structures are seen as avoiding the pitfalls of hyperleverage, opaque structures and specious valuations that have been at the center of the global financial crisis. Observers attribute the recent growth trend in Islamic finance in part to this feature. “You often hear Islamic finance referred to as the ‘flavor of the month’” observes Azrulnizam Abd Aziz, CEO of Standard Chartered Saadiq Berhad. “In reality it is the flavor of the year – or several years for that matter.”
A return to values
More than merely a “flavor,” in fact, this sentiment represents a growing sense that finance, having lost its way in the excesses and scandals that metastasized in the market over the past years, needs to return to the ethics and values that once lay at the bedrock of its institutions and practices, and that the practices embedded in Islamic finance can guide institutions to this outcome. No less an institution than the Roman Catholic Church has weighed in on this subject. In a statement on March 4 issued via its official newspaper, “Osservatore Romano,” the Vatican noted: “The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service.” Bank Negara Malaysia’s Dr. Zeti agrees: “The values embedded in Islamic finance, including justice, fairness and equity – these values are important and they bring us back to basics, back to what financing used to be.”
How has Malaysia come to its position of prominence in Islamic finance? “Malaysia is unique in several respects” opines CIMB Islamic Bank CEO Badlisyah bin Abdul Ghani. “Here we have a majority Muslim population, but also a sizable non-Muslim community. Our financial infrastructure has grown out of a deliberate desire to ensure that the needs and interests of all Malaysians are met. As a result we have a thriving Islamic banking market alongside an established and highly professional conventional (i.e. non-Islamic) system – something that is truly unique in the world.”
Outside the ummah: The attraction of Islamic finance to non-Islamic participants
Having the knowledge and insights from both markets gives Malaysian regulators, issuers, investors and intermediaries the benefit of understanding the comparative advantages and disadvantages of each. One result of this knowledge is the ability to offer structures and conditions that can attract broad interest, not only from traditional Islamic sources but from established conventional financial markets like London, Frankfurt, Hong Kong and Singapore. Bank Negara Malaysia’s Dr. Zeti notes that the attractiveness of Islamic capital markets offerings applies to financial issuers and investors alike. “Our first global sukuk, issued in 2001, was oversubscribed,” she notes “with about 50 percent of the issue placed among traditional Islamic investors from the Middle East and the remainder from both Muslim and non-Muslim sources in Europe and Asia.” Non-Muslim investors “see Islamic financial products as a new asset class, attractive as a means of diversifying their portfolios.” As evidence of this growing popularity, Dr. Zeti points to the large transaction size of several recent Malaysian issues, including the largest equity-linked sukuk (US$850 million) for Khazanah Nasional and the largest sukuk of any type (RM15.35 billion or US$4.8 billion) for Binariang GSM, both in 2007. Both of these issues were also heavily oversubscribed.
Good regulation
The global financial crisis has revealed a regulatory deficiency in many markets. Malaysia is an exception to that trend, and a sound regulatory regime has been a critical ingredient to the successful track record of both Islamic and conventional finance. Malaysia has a distinct regulatory structure for both its domestic and offshore market. In the domestic market, Bank Negara Malaysia is responsible for the banking sector while the Securities Commission, under the jurisdiction of the Ministry of Finance, oversees the Bursa Malaysia (stock exchange). In addition Malaysia boasts one of the world’s up-and-coming International Financial Centers (IFCs) – the Labuan International Business and Financial Center, for which regulatory oversight of banking as well as securities and capital markets resides with the Labuan Offshore Financial Services Authority (LOFSA).
Bank Negara Malaysia’s Dr. Zeti points out that in Malaysia the central bank is able to conduct monetary policy and manage liquidity via Islamic money market products. Like most central banks, Bank Negara Malaysia operates a national payment system to facilitate both large-value and retail payments, but an added feature in Malaysia is that “Islamic and conventional money market instruments are not commingled. Our payment system has the capacity to facilitate each payment stream separately, and that makes it “halal” (Shariah compliant).
Regulatory responsibilities do not end with the conventional central bank mandates of conducting monetary policy, providing supervisory oversight of the banking sector and operating the national payment system. In Malaysia the primary financial regulators have demonstrated the ability to work together – with both domestic and international organizations and policymakers – to support other institutions critical to the overall success of the system. One important example of this can be seen with the creation of the Islamic Financial Standards Board (IFSB) in 2002.
The IFSB came about as recognition that the distinct characteristics of Islamic finance and its rapid growth into the mainstream of global finance necessitated that its activities come under the auspices of a different framework from that governing conventional finance. In her capacity as IFSB Inauguration Steering Committee Chairman, Bank Negara Malaysia’s Dr. Zeti commented thus in her welcoming address: “A separate regulatory framework therefore needs to be developed in view of the unique risks in Islamic financial transactions to provide for their effective assessment and management.” Initial support for the foundation of the ISFB as an international promulgator of prudent supervisory and disclosure standards came from the leaders of a handful of central banks, the Islamic Development Bank, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), the International Monetary Fund (IMF) and the World Bank. In recognition for its leadership role in this development, Malaysia was mandated to lead the steering committee to establish the organization and to host the organization in Kuala Lumpur. A glance at the press release section of the IFSB website reveals a steady stream of linkages, events and initiatives with central banks and other financial institutions around the world including the Bank for International Settlements (BIS), the organization responsible for the Basel II Revised International Capital Framework.
The human capital imperative
Another important institution that bears the hallmark of the cooperative and proactive spirit of Malaysia’s regulators is the Malaysia International Islamic Financial Center (MIFC). MIFC is a collaborative effort between the country’s main financial regulators: Bank Negara Malaysia, the Securities Commission, Bursa Malaysia and Labuan Offshore Financial Services Authority, together with industry participation form the banking, takaful and capital market sectors in Malaysia. It was created in 2006 in the wake of Malaysia’s financial market liberalization to provide a responsive, comprehensive platform for foreign financial institutions to use Malaysia as a venue for Islamic finance. On the occasion of the second London Sukuk Summit Awards of Excellence, MIFC was awarded “Best International Islamic Financial Center.”
One of MIFC’s core commitments is the development of the human capital necessary to take Islamic finance to the next level of its evolution. The one thing that all financial markets have in common is their absolute dependence on talented professional skills to sustain growth and success. Islamic finance requires not only skilled financial intermediaries, regulators and providers of third party professional services like legal and tax counsel, but also experts schooled in the principles of Shariah law and customs. An integral feature of any Islamic financial transaction is the presence of a Shariah advisory council to evaluate and rule on compliance, e.g. with regard to the prohibition of riba and gharar, and the avoidance of activities considered “haram” (not allowed) under Islam, such as alcohol, gambling or pork.
Of course in Islam there is no one single strand of agreement on all matters pertaining to the faith, and the diverse opinions and interpretations (“ijtihad”) of Islamic scholars in different countries representing different legal traditions are a testament to the fact that not everybody agrees on what in Islamic finance is halal or haram. According to Bank Negara Malaysia’s Dr. Zeti: “It is quite important that we move towards harmonization and mutual recognition of what has been approved [in terms of Shariah decisions] in different jurisdictions, and in order to bring this about we have encouraged engagement by leading Shariah scholars from all over the world for more than two or three years now, and invested considerable funds into facilitating these discussions. One prominent initiative in this regard was the creation of the International Shariah Research Academy for Islamic finance (ISRA). ISRA is a part of the International Center for Education in Islamic Finance (INCEIF), an accredited university that offers Master’s and Doctoral programs in Islamic finance along with numerous programs and initiatives (for more on INCEIF please see the separate article featured in this report). The goal of ISRA is to “contribute towards strengthening human capital development in the area of Shariah and provide for a greater platform amongst practitioners, scholars, regulators and academicians via research and dialogues, both in the domestic and international environment” according to a Bank Negara Malaysia press release following ISRA’s launch in May 2008.
Conclusion
Dr. Zeti sees numerous challenges ahead in the months and years to come, but she remains confident in the ability of Islamic finance to occupy a still greater space in the international financial marketplace. “Islamic finance within a financial system provides for linkages that increase knowledge and awareness while promoting the dissemination of best practices throughout different markets and communities.” She reiterates the role Islamic finance can play in the worldwide movement to restore ethics and values to finance: “Islamic finance represents the basic fundamental aspects of what we know traditional finance to be, and contributes to international financial stability because of the inherent nature of checks and balances embedded in its practices. These values and ethics are universal. In Islamic finance they are explicit, visible and worthy of emulation not only in Malaysia and other traditional Islamic markets, but worldwide.”
