Tuesday, 15 February 2011

The missing puzzle piece in Malaysia

Today’s Achilles heel in Islamic finance is the “under-developed” Islamic equity capital market.

The previous Islamic Finance 2.0 Column, Where is Islamic Equity Capital Market?, gave an overview of today’s situation: syariah screening results in a large bias towards G20 countries and Muslim majority (OIC) countries have conventional debt bias.

But what about Malaysia?
The informed world acknowledges Malaysia’s remarkable holistic leadership in Islamic finance, including US Secretary of State, Hillary Clinton’s, recent glowing comments.
But, why aren’t Islamic funds from GCC and elsewhere finding their way to the syariah-compliant companies listed on Bursa Malaysia?

Bursa’s website says, “… 88 per cent (885 companies on Main market or 778 of the securities) currently listed on Bursa Malaysia are syariah-compliant and represent two-thirds of Malaysia’s market capitalisation”. Impressive, but does that qualify to make it, say, a destination for Islamic equity investing, i.e., an Islamic stock exchange?
The Dubai Financial Market, to address the Islamic equity capital market vacuum, became the world’s first “Islamic” stock exchange in 2006, but it has not seen an exponential increase in trading volumes, cross/dual listing of syariah (compliant and based) companies from outside of UAE.
The Islamic debt capital market will provide guidance, assistance and contribution to the build out/up of the Islamic equity capital market, but it requires attention to the issue and the will to do something about it.

Index Provider versus Stock Exchange
The syariah screening methodology of S&P Malaysia BMI syariah Index, Table 1, shows only 38 syariah-complaint companies with a market capitalisation of US$38 billion (RM115.52 billion) in Malaysia. More interestingly, the same table shows only three syariah-compliant financial companies (out of 30) with 4 per cent market capitalisation weighting.
International investors, from funds to family offices, typically look closely at indexes, especially for emerging markets, from the major index providers to gauge opportunities and avoid pitfalls. Unlike a stock exchange, whose composite index will cover all listed companies, index providers apply methodologies to remove illiquid companies, companies with small free float, and so on. Thus, many investment products, from funds to exchange listed instruments, are licensed from index providers and not stock exchange indexes. For example, the world’s largest Islamic ETF, in terms of assets under management, MyETF listed on Bursa Malaysia, is off the Dow Jones Islamic Market index for Malaysia.
Here, the message seems to be the syariah-compliant universe of companies listed on Bursa Malaysia is 38 and not 778, and the investable Islamic finance sector has only three companies.
For a leading and pioneering Islamic finance hub like Malaysia, it sends a mixed signal, to say, GCC Islamic (and even conventional) investors that investing in listed compliant companies in this Islamic financial hub is extremely limited.

Saudi Arabia
Saudi Arabia is not only the largest Islamic finance and investing market in the GCC but also a G20 country, and with the price of oil expected to stay above US$70/barrel (RM212.80/barrel) for the foreseeable future, many eyes are on the country’s budget surplus.
Today, Malaysia is competing with not Saudi inward opportunities, but also other Islamic finance hubs and G20 syariah-compliant investment opportunities for investor attention.
The syariah screening methodology of S&P Saudi Arabia BMI syariah Index, Table 2 (below), shows 87 syariah-compliant companies with market capitalisation of US$97 billion (RM294.88 billion) in Saudi Arabia.

More interestingly, the same table shows 15 syariah-compliant financial companies (out of 25) with 30 per cent market capitalisation weighting.
Thus, Saudi Arabia, using S&P screening methodology shows: (1) 81 per cent of companies are syariah-compliant and 30 per cent for Malaysia, and (2) 69 per cent syariah-compliant market capitalisation and 31 per cent for Malaysia.
Furthermore, in examining the conventional and syariah stock count for the various sectors, consumer discretionary, telecommunication, utilities, etc, we see same number of companies, implying low levels of conventional debt on company’s balance sheets.
In applying the syariah financial screens on Muslim majority (OIC) countries with stock exchanges, many companies fail the “debt” screen as an equity culture does not yet exist.
Thus, from the two tables on the conventional and syariah stock count in various sectors for Malaysia and Saudi Arabia, we observe the following from Table 3:
There are two takeaways from the above table: 1. Malaysia, when compared with GCC countries, has all 10 economic sectors, as the information technology sector is presently missing according to S&P index categorisation.

Sukuk & Equity
The second take-away is Malaysia can continue to show its leadership in Islamic finance to the OIC/G20 countries on how to “equitise or de-leverage” the balance sheet of companies so they become syariah-compliant.
For example, companies in Malaysia, like PLUS, have issued sukuk (of international standards) and use the proceeds to retire conventional/BBA debt, hence, pass the “debt” financial screen of an index provider to be in an Islamic index and widen its shareholder base.
Table 3, above, shows the conventional and syariah stock count for Malaysia, and in many of the sectors, ex-financial, Ijara based corporate sukuk may be the right mode of contract for raising money to refinance conventional debt. Obviously, this assumes the “conventional” efficiencies for sukuk issuance.
The end result includes more corporate sukuk issuance from big name companies, adding to secondary market liquidity, development of yield curves, increase of sukuk funds, and so on.
Concurrently, it would increase the number of syariah-compliant companies and add to compliant market capitalisation.
This is the true beginning of an Islamic equity capital market development, and its jump started from an Islamic debt capital market instrument.
Malaysia, are you listening?
The writer is Global Head of Islamic Finance for Thomson Reuters, based in New York.

Read more: The missing puzzle piece in Malaysia http://www.btimes.com.my/Current_News/BTIMES/articles/20110214234925/Article/index_html#ixzz1E2Fc2yhX

Monday, 14 February 2011

Benefits of Islamic banking

Islamic banking and the finance industry is growing at an annual rate of 20%. Many international as well as local institutions have stepped into this multi-billion dollar booming industry by establishing its Islamic wings and units. International giant banks such as HSBC (HSBC Amanah), Citi Bank (Citi Islamic) and Standard Chartered have already established their Islamic units and functioning in the Middle East region.

In Sri Lanka, despite the Muslim population being just 8% of the total population, a considerable growth is reported in the past few years with the establishment of Amana, Ceylinco Profit Sharing, First Global and a new comer ABC Barakah. Recently it is reported that the largest state owned commercial bank, Bank of Ceylon intends to commence its Islamic banking unit in early 2008. All these new entries imply that this alternative banking system has drawn the attention of Muslims as well as non-Muslims due to its unique developmental characteristics.

The underlying principle of Islamic banks is the principle of justice which is an essential requirement for all kinds of Islamic financing. In profit sharing of a financed project, the financier and the beneficiary share the actual or net profit/loss rather than throwing the risk burden only to the entrepreneur. The principle of fairness and justice requires that the actual output of such a project should be fairly distributed among the two parties. If a financier is expecting a claim on profits of a project, he should also carry a proportional share of the loss of that project.
In contrast with conventional finance methods, Islamic financing is not centered only on credit worthiness and ability to repay the loans and interest; instead the worthiness and profitability of a project are the most important criteria of Islamic financing while the ability to repay the loan is sub-segmented under profitability.

One of the unique and salient characteristics of Islamic banks is that the integration of ethical and moral values with its banking operation. The ethical and moral consideration of Islamic banks cannot be detached and their behavior should be consistent with the moral and ethical standards laid down by the Islamic Shari’ah.
Unlike the conventional banks, the financing of Islamic banks are restricted to useful goods and services and refrain from financing alcoholic beverages and tobacco or morally unacceptable services such as casinos and pornography, irrespective of whether or not such goods and services are legal or not in a given country.
In contrast with conventional banks, Islamic banks do not consider only the credit worthiness and interest rate as standards; instead they must apply Islamic moral/ethical criteria in their provision of financing. This adds another merit for Islamic banks since there is a benefiticial impact on the productivity in the economy as it reduces the social and economic cost of such harmful products and activities.

Another important characteristic which forms the basis for the development of Islamic banks is the relationship with depositors. They deal with their customers on investment grounds rather than a pre-determined fixed interest rate. They invest the money of their depositors on high profitable projects after going through a strategic analysis in order to give a substantial return to their depositors. Thus in Islamic banking industry, each bank will attempt to out-perform other banks if it wants to attract funds from investors. And the ultimate result is that a high return on investments for the investors, which is unlikely in a conventional bank where it deals with their depositors on a pre-determined fixed interest rate.

Furthermore Islamic banks eliminate the barrier between those who save and those who invest, and bring them closer to the real market. The nature of the financial intermediation of Islamic banks significantly defers from conventional banks and it is in harmony with real market and developmental changes in it.
It is important to highlight some of the challenges faced by the Sri Lankan Islamic banks. Although there are many, the most important challenges are the lack of Islamic banking professionals and the lack of Shari’ah scholars who have specialized in Islamic economics. Further the Shari’ah board should have a fair influence on the bank’s operational and strategic planning. For this process to be successful, the Shari’ah boards of our Islamic banks should absorb Islamic scholars based on their technical expertise rather than their popularity.