In the third of a series of 6 articles, economist Baljeet Kaur Grewal looks at the growth of the private debt securities market and within that niche, the growth of Islamic debt instruments.
THE Malaysian debt capital market has demonstrated resilience and increased in magnitude as an alternative source of financing for the economy, fundamentally due to the accommodative interest rate environment, a pick-up in domestic economic activity and ample liquidity conditions.
The recognition that bonds account for a more stable source of long-term financing, thus spreading the risk element caused by cyclical economic downturns has also added to the allure of fixed-rate securities.
Concurrently, a rather new and more exciting area within the capital market that has made headways in recent times is the area of Islamic debt.
In a niche mainstream financial industry, Islamic debt instruments account for a large proportion of the private debt securities (PDS) market. In the last 6 years, the composition of Islamic fixed-rate securities grew unabated and increased in significance.
Demand for Islamic debt instruments, which accounted for only 7% of total bonds raised in 1999 grew to 25% in 2000 and subsequently to 36% in 2001, primarily due to investor awareness of alternative funding sources, i.e. Islamic instruments and the increased number of Islamic funds launched over the years.
No fewer than 60% of all Malaysian domestic bonds are now Syariah-compliant, especially the larger issues, and this proportion continues to grow.
The result is that Malaysia’s Islamic financial landscape has advanced in terms of diversity of instruments and its modernity, as well as boasts a dual banking model, whereby a developing Islamic financial system exists in parallel to the conventional banking system.
To chart the growth of Islamic fixed-income securities, approximately RM33.5bil worth of Islamic bonds were issued in the last 5 years. Of this amount, RM15.8bil (or 47%) were issued to fund infrastructural activities comprising power generation, water supply, bridges, roads and ports.
The Al-Bai Bithaman Ajil (“ABBA”) structure has been the preferred choice to finance such projects with long gestation periods. Under this principle, the financier purchases an asset from the issuer and sells it back to the same party at a premium.
Besides ABBA, another popular Islamic PDS tool is the Murabahah concept which caters for short- to medium-term requirements. Other Islamic concepts available to the market include Istisna, Ijarah, Mudharabah and Musyarakah.
So why are Islamic bonds increasingly popular? The advantages fundamentally lie in the structure of Islamic finance itself. Islamic bonds provide an avenue for Islamic investors to invest in Syariah-compliant investments thus, guaranteeing access to a larger investor base, as well as providing potential lower pricing to issuers via the wider investor pool from the participation of large Islamic investors.
In the international foray, the Islamic financial market is estimated at US$180bil with a projected growth rate of 15% annually. It is anticipated that the market will be responsible for managing at least 50% of the total savings of Muslims worldwide in 8 to 10 years' times.
There are approximately 250 global financial institutions that currently operate in approximately 75 countries promoting Islamic investment banking products. London and New York have also been identified as the two largest Islamic financial hubs outside the Middle East.
In comparison to the total market size, current global Islamic bonds only account for US$38bil or 15%, depicting the tremendous opportunity and growth potential of the industry.
Nevertheless, like all financial mechanisms that are in the formative stages of development, the Islamic industry poses some overreaching challenges. The main hurdle identified is in accessing long-term investors and ensuring sustainability of the Islamic industry.
Further to this, creating a deep and liquid secondary market for Islamic instruments through the enhancing of risk management tools and innovation of new products will ensure that standards remain adaptive and effective in riding the evolutionary waves of financial innovation.
Establishing sizeable and organised institutions, ongoing research and development as well as consensus among Islamic jurists and scholars on Syariah issues also remain an integral core of Islamic finance.
As Malaysia moves to establish itself in the international foray of Islamic finance, various initiatives have been undertaken.
The advent of Malaysia’s participation in the establishment of Accounting and Auditing Orga- nisation for Islamic Financial In -stitutions (AAOIFI), the Inter- national Islamic Rating Agency (IIRA) and the chair of the Islamic Financial Services Board (IFSB) will further develop Malaysia’s niche as a regional financial centre for Islamic banking and finance, as well as tapping comparative advantage from other Middle Eastern member countries.
The Malaysian bond market has thus far displayed exemplary growth with the onset of Islamic debt, which has further enhanced competitiveness and sophistication in the increasingly robust and competitive world of banking, thus contributing towards the resilience of the overall international financial architecture.
l The next article will examine the conditions for enhancing liquidity in the secondary market.