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Mohd Radzuan Ahmad TajuddinIslamic Capital Market Business Group

29 September 2011

Islamic Finance : Structure and Instruments Ankara, Turkey26-30 September 2011

Overview of the Malaysian Islamic Capital Market

• The evolution of Islamic finance began with the setting up of the Pilgrims Fund Board - savings mechanism under which funds for performing the Hajj were set aside to cover the costs of performing the annual pilgrimage

• Government and regulatory bodies recognized the need to develop Islamic finance in order to create a financial niche for Malaysia

• The evolution of Islamic finance in Malaysia :

1969 : Establishment of Pilgrim Fund Board

1983 : Islamic Banking Act enacted and the establishment

of first Islamic bank

1984 : Takaful Act enacted and the establishment of first

takaful company (Islamic insurance)

1993 : Securities Commission Act enacted providing SC with

mandate to develop capital market

2007 : Capital Market and Services Act

Islamic finance in Malaysia - background

Fundamentalfor

IslamicFinance

development

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Islamic finance activities in Malaysia…..

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Capital Market Institutional Framework in Malaysia

• Established on 1 March 1993 under the Securities Commission Act 1993

• Regulate and promote the development of the capital market

• Reports to the Minister of Finance• Capital Markets and Services Act

2007

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Securities Commission Malaysia as the Main Regulator for the Capital Market

Development of the capital market

Supervising exchanges, clearing houses and central depositories

Licensing and supervising all licensed

persons

Regulating all matters relating to fund management

activities

Regulating all matters relating to securities and futures contracts

Regulating the take-overs and mergers of companies

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The Islamic Capital Market (ICM) in Malaysia has Evolved..........

• Has evolved into an efficient conduit for mobilisation of funds for Malaysian and foreign corporates

long term fund raising and investment; enhances depth & resilience of Malaysian Islamic financial system and overall financial system

68% of outstanding corporate bonds are structured using Shariah principles –information as of H1 2011

89% of companies on the stock exchange are Shariah compliant

• Malaysian ICM products are accepted by both Islamic and non-Islamic local investors as well as investors across various jurisdictions Conventional investors regard ICM products as a new asset class Emergence of new demand from the Middle East, South-East Asia, South

Asia and North Africa

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……..and Continues to Spearhead Further Development

• Malaysia is regarded as a center for Islamic finance− About two thirds of sukuk globally originates from Malaysia − Islamic unit trust is the fastest growing segment of the Islamic capital

market − Leading international fund management companies establishing operations

in Malaysia

• Issuance of sukuk is not confined to Islamic institutions− Multilateral institutions such as World Bank and IFC have issued sukuk− Non-Islamic institutions have issued sukuk − Non-Muslim majority countries have shown interest to issue sukuk

• Local and foreign financial institutions are now actively intermediating and structuring ICM products

− Sukuk− Islamic structured products− Islamic exchange traded funds− Islamic real estate investment trusts

ICM is a Key Component of the Malaysian Capital Market*………..

Total Capital MarketRM2,125.5 billion

ICM

RM1,151.8 billion

* As at 30 June 2011 # Include sovereign & corporate sukuk

54%

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Islamic Banking

Islamic capital market

Takaful

• To effectively play its role as an efficient conduit

• Contributes to the overall stability of Islamic financial services sector : Islamic banking to mobilise deposits and

provide financing Takaful to provide mutual protection Islamic capital market to provide long

term fund raising and investment and enhance depth & liquidity of Islamic financial system

.....and Completes the Creation of Comprehensive Islamic Financial Services Sector …

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Achieved through Holistic and Phased Approach

• Equity market• Bond market• Derivatives market• Stockbroking industry• Market institutions• Investment management

Launched in 2001, the Capital Market Masterplan (CMP) provides a blueprint for long-term strategic development of the Malaysian capital market with 152 recommendations covering 11 areas :

PHASE 3PHASE 2PHASE 1

• Further strengthen key sectors and gradually liberalise market access

• Further strengthening of market processes and infrastructure and enhancing international positioning in areas of comparative advantage

• Strengthen domestic capacity and develop strategic and nascent sectors

20062006 2010201020042004 2005200520012001 20032003

• Regulatory framework • Corporate governance• Islamic capital market• Technology & e-commerce• Training & education

• More than 90% of plans implemented• Commitment to phased liberalisation• 13 specific recommendations for Islamic capital market – positioning Malaysia as

an international ICM centre

Growth with Governance“... describes the challenge for

our capital market to expand its

role in invigorating national

economic growth while

addressing concerns about the

efficacy of markets in the

aftermath of the global financial

crisis.”

Capital market exceeds RM2 trillion- Economies of scale

Core segments are regional leaders

- Connectivity

- New opportunities

Large institutional funds

- Efficient intermediation

- Diversity

Liberalised participation

- Further internationalisation

- Hub opportunities

CMP2: From foundation-building to transforming competitive dynamics

Different challenges in CMP2

Source: SC

RM1,275 bil

RM444 bil

RM759 bil

RM273 bil

RM1,050 bil

RM294 bil

RM377 bil

RM55 bil

RM512 bilRM84

bil

Equity market

Bond market Investment management

Derivatives market

Islamic Capital Market

2000

• Internationalise to expand scale

- Foreign listings and issuances

- Expansion into international markets

• Create hub opportunities

- Middle and back office

- Education and training

• Widen ICM’s international base

- Expand service infrastructure

- Value-add Islamic fund management

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CMP2: Maximise growth opportunities

Source: SC

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Thrust of CMP2 for ICM: Internationalisation of ICM

Expand international intermediation capabilities Strengthen Malaysia’s positioning in the global exchange landscape

Strengthen connectivity of clearing and settlement infrastructure and reduce friction costs

Pursue cross-border regulatory arrangements to facilitate the expansion of domestic intermediaries abroad

Identify hub opportunities in middle and back-office functions

Widen Islamic capital market’s international base

Build scale in the Shariah-compliant equity, sukuk and investment management segments

Strengthen service and operational infrastructure to expand ICM’s international reach

Promote shift from Shariah-compliant to Shariah-based approach

Collaborate with industry to expand range of Shariah-compliant stockbroking and portfolio products and services

Develop seeding strategy to increase diversification of value-add Islamic investment strategies and styles

Increase international collaboration on Shariah research and product development

Develop a code of conduct for Shariah advisers

Strengthen training and professional development to increase supply of Shariah experts

Expand growth boundaries by tapping global opportunities to grow scale and to capitalise on hub opportunities

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What is ICM?

ICM refers to a market where the capital market transactions, operations and activities are carried out in ways that conform with Shariah principles and requirements.

prohibition of payment or receipt of riba (interest)

prohibition of underlying contract with elements of gharar (ambiguity)

prohibition of maisir (gambling) activities

prohibition of the production and sale of goods and services that are prohibited in Islam

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Fundamental Aspects of ICM

Islamic contracts are the underlying principles for all ICM products and services

Contract of exchange

Contract of participation

Bai bithaman ajil Murabahah Istisna’ Ijarah Salam

Wakalah

Contract of agency

Musharakah Mudharabah

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A Sound Shariah Framework is Fundamental for ICM Development

• Main thrust of Islamic capital market is compliance with Shariah principles (Islamic jurisprudence)

• National level Shariah Advisory Council (SAC) established under the Capital Markets and Services Act 2007

− Confirms the role of SAC as the highest authority for the ascertainment of Shariah principles in Islamic capital market business or transaction

− Provides clarity and consistency with regard to Shariah matters

• SAC works closely with industry to facilitate new products/concepts

• SAC’s resolutions are published for the benefit of issuers, investors and market players

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The SAC Contributes Significantly to the Development of ICM

Facilitates development and regulation of new products

Provides greater clarity and enhances market confidence and integrity through dissemination of Shariah rulings

Regular interaction with industry and other Shariah experts provide useful feedback for decision-making

Participation at international conferences and dialogues enhances awareness and understanding of Malaysia’s Islamic capital market

“The SAC has been instrumental in the development of innovative Islamic products and services and played a key role in transforming a niche growth sector into a core component of the Malaysian capital market. This is possibly the single most important catalyst for the rapid growth of the Islamic capital market in Malaysia.”

“The SAC has been instrumental in the development of innovative Islamic products and services and played a key role in transforming a niche growth sector into a core component of the Malaysian capital market. This is possibly the single most important catalyst for the rapid growth of the Islamic capital market in Malaysia.”

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Malaysian ICM Offers Comprehensive Array of Shariah Compliant Products and Services

Products

Services

• Shariah-compliant stocks • Islamic unit trusts• Islamic REITs• Sukuk• Islamic ETFs• Islamic Structured Products• Islamic Venture Capital/Private Equity

• Islamic stockbroking• Islamic fund management• Islamic equity indices• Commodity trading platform

To facilitate IFIs liquidity management under tawarruq arrangement

• Corporate finance and advisory

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Future development! Islamic alternative fund Islamic gold ETF Shariah-compliant derivative

Future development! Islamic Stock Selling and Buying (ISSB) platform

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Shariah-Compliant Securities

Securities (stocks/shares) of a company listed on the exchange (Bursa Malaysia) which are classified as Shariah permissible for investment

Primary business and investment activities that generate income for the company must conform to Shariah principles

What are Shariah-compliant securities

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Guiding Principles for Shariah-Compliant Securities

Financial services based on riba (interest)

Gambling Manufacture or sale of non-halal

products/services Conventional insurance Entertainment Manufacture or sale of tobacco-based

products or related products Conventional stockbroking or share

trading Other activities deemed non-

permissible

Classified as Shariah-compliant if the company is not significantly involved in the following activities:

Other criteria:

Interest income from conventional fixed deposits/interest bearing instruments

Dividend received from investment in other Shariah non-compliant securities

Other criteria:

Interest income from conventional fixed deposits/interest bearing instruments

Dividend received from investment in other Shariah non-compliant securities

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Guiding Principles for Shariah-Compliant Securities for Mixed Companies

Must be minimum and at tolerable level – specific benchmarks are established

Must be minimum and at tolerable level – specific benchmarks are established

Classical scholars discussed as to what extent Shariah non-compliant activities are allowed

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Specific Benchmarks are Established

5% benchmarkto assess the level of mixed contributions from the activities that are clearly prohibited such as riba (interest-based companies like conventional banks), gambling, sale of non-halal products/services

10% benchmarkto assess the level of mixed contributions from the activities that involve the element of ‘umum balwa’ which is prohibited element affecting most people and difficult to avoid e.g. interest income from fixed deposits in conventional banks

25% benchmarkto assess the level of mixed contributions from the activities that generally permissible according to Shariah and have an element of maslahah to the public, but there are other elements that may effect the Shariah status of these activities e.g. hotel and resort operations, share trading, stockbroking, as these activities may also involve other activities that are deemed non-permissible to the Shariah

20% benchmarkto assess the level of contributions of mixed rentals from Shariah non-compliant activities

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A Vibrant Shariah-Compliant Securities……

Shariah compliant securities constitute 89% of all stocks listed on Bursa Malaysia

The SC has issued a list of Shariah compliant securities since 1997 and the list is updated twice a year (May and November)

The introduction of Shariah equity indices on Bursa Malaysia:

FBM Emas Shariah;

FBM Hijrah Shariah; and

DJIM Malaysia Titan 25*The SAC updates the list twice yearly i.e. end may and end November

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.....Acts as Catalyst for Other ICM Products and Services

It sets the foundation for Islamic equity investment

Prior to the issuance of Shariah List :

– Participation by Muslim investors – minimal

– Insufficient or no clear guidance on the stocks that can be traded (Shariah) - Listed companies are involved in various activities (halal and haram)

– The scenario had left Muslim behind in equities or shares investment

– Lost opportunity (in the early 1990s) when there was significant increase in the number of companies listed on the stock exchange

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Islamic Fund Management Companies

• Islamic fund management companies are allowed have 100% foreign ownership

• Islamic funds are permitted to invest 100% of assets abroad

• 10-year stamp duty exemption and tax incentives on wide range of Islamic investment instruments

• Income tax exemption on all Islamic fund management activity fees until 2016

• One-stop center at the Securities Commission (SC) for all fund management queries

• To-date, 16 IFMCs – 9 foreign-owned, 4 locally-owned and 3 on a joint venture basis

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Islamic Fund Management Companies (cont’d)

* Foreign-owned IFMCs

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Islamic Unit Trusts

• Fastest growing segment of the Islamic capital market – CAGR of 25% over past 5 years

• High growth from a small base and building critical mass

• Largest number of Islamic unit trusts in the world

• Mutual recognition arrangements with Dubai and Hong Kong

71 83 100134 149 150 155 160

291340

416

521579 565 584 595

0

100

200

300

400

500

600

700

2004 2005 2006 2007 2008 2009 2010 Jun-11

Num

ber o

f fun

ds

Islamic funds Total funds

6.8 8.5 9.2 16.9 17.2 22.08 24.04 26.2

87.4 98.5121.8

169.4

134.4

191.71

226.81249.6

0

50

100

150

200

250

300

2004 2005 2006 2007 2008 2009 2010 Jun-11

Size

of f

unds

-NAV

(RM

bln

)

Islamic funds Total funds

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Islamic Real Estate Investment Trusts (I-REITs)

• Malaysia has an established framework on shariah-compliant REIT and is first to issue Guidelines for Islamic REIT in 2005

• Malaysia is first in the world to have a Shariah-compliant REIT listed on the stock exchange

• Currently, Malaysia has 3 Shariah-compliant REITs listed on its stock exchange -

– hospital REIT (Al-’Aqar KPJ REIT)-the first Islamic REIT in the world

– plantation REIT (Al-Hadharah Boustead REIT); and

– commercial building REIT (Axis REIT)

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Islamic Exchange Traded Fund (ETF)

• Essentially a unit trust fund that is listed and traded on an exchange. Performance objective is to closely track performance of underlying benchmark or index

• Malaysia launched the Asia’s first Shariah compliant ETF in January 2008

• The fund, known as MyETF Dow Jones Islamic Market Malaysia Titan 25 (MyETF-DJIM25) . Has an initial authorized fund size of 10 billion units, representing a basket of securities designed to track the performance of the Benchmark Index namely the Dow Jones Islamic Market Malaysia Titan 25 (DJIM25)

• The DJIM25 is made up of 25 Shariah-compliant securities of companies listed on Bursa Malaysia

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• In 2011, 72% of total corporate bond issued were sukuk

• Amount of corporate sukuk issued in 2011: RM24.6 bn

• 58% of outstanding corporate bond in Malaysia are sukuk

• 64% of total sukuk outstanding globally are from Malaysia -IFIS

Malaysia has a well established sukuk market

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Internationalisation of ICM

Malaysia is committed to working closely with other centres to create international linkages and broaden markets for ICM products and services, creating opportunities and stimulate cross border investment flows.

So far, SC has signed MRAs and MoUs with : MRA with DFSA - both corporations will work closely to distribute

Prudential-managed Shariah funds in Malaysia and the Dubai MRA with HKSFC - to facilitate greater cross-border marketing and

distribution of Islamic funds      Bilateral MoU with Luxembourg on information exchange Letters of Exchange with CBRC and MoU with CSRS of China –

Malaysia recognised as an approved investment destination

SC has also established International Advisory Council to provide strategic guidance and international perspectives.

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Thank You