Islamic investing - Malaysia's challenges
While growth in Malaysia’s Islamic capital market has outpaced the expansion in the conventional financial sector in the last decade, the absence of a global specialist infrastructure will hinder future development, according to Abdul Jalil Rasheed, CEO at Aberdeen Islamic Asset Management.
“The problem is that if one were to invest in a global Shariah-compliant equity fund, the operational eco-system might not exist in some countries,” says Rasheed. “Currently, almost 25% of the Malaysian unit trust industry is Shariah-compliant, however it must be noted that even as this market share grows, conventional fund management will always be a larger component of the market, simply because it has a better infrastructure.”
Malaysia is the third-largest market for global Islamic finance products and the world’s largest issuer of Islamic bonds, also known as Sukuk. Under its Capital Market Masterplan 2, the country’s Shariah-compliant financial sector is expected to sustain double-digit growth to reach almost RM3trn ($961bn) in 2020.
A lack of integration with the global financial system, differing interpretations of permissible transactions and the absence of uniform rules and regulations are challenges that the country has to overcome to support future growth in the sector. Malaysia is also predominantly a domestic market and denominated in ringgit, limiting the interest from overseas investors. In comparison products from the Middle East are mostly US-dollar denominated and offer a broader appeal.
Malaysia’s Islamic capital market grew 13.6% annually from RM293.7bn in 2000 to over RM1.0trn in 2010, according to government data. As at the end of 2010, more than half of Malaysia’s capital market assets were Shariah-compliant.
Government-owned companies, including utility company Tenaga, Bank Negara and state investment company Khazanah Nasional are active issuers of Islamic bonds, which pay asset returns to comply with the religion’s ban on interest. The asset class options for Islamic investing are limited. Under Shariah-law, investors are prohibited against speculation or investing in companies with business related to alcohol, tobacco, conventional financial services, military arms, pork-related products and entertainment. Rasheed adds: “The benefits are that Islamic investing is almost like an ethical fund but a layer deeper is to ensure even operationally the fund is Shariah-compliant through the non-existence of any interest elements or so-called riba.”
Aberdeen Asset Management is currently one of 18 Islamic fund managers in Malaysia. While the company currently does not have any Shariah-compliant retail funds in its stable, it has been managing such funds for institutional investors.
Rasheed says the funds’ performance has been better compared with its conventional peers, mainly due to not having any exposure in the financial sector which was badly affected in the 2008 global financial crisis.
Malaysia’s Islamic market has attracted both Shariah and conventional investors. Rasheed warns the pitfall is assuming that Islamic investments will always outperform the market. “That is not true even though it is a Shariah-compliant fund; it is exposed to movements in the stock market.”
Many sovereign wealth and pension funds have exposure to Sharia-compliant, publicly listed screened companies. Some of the world’s biggest sovereign funds are from the Muslim countries of the Middle East. This includes Abu Dhabi Investment Authority, Saudi Arabia’s SAMA and the Kuwait Investment Authority.
“Pension fund sizes are huge so we cannot expect that all their investments will be in Islamic investments,” says Rasheed. “They must strike a balance between conventional and Shariah.”
While the growth of these funds should help boost the development of the Islamic capital market, in reality, the value of Shariah-compliant assets is still less than 1% of the global financial system. Islamic bond sales, which jumped 68% to $26bn in 2011, are still below 2007’s record $31bn and are dwarfed by the $764bn in bonds sold globally this year.
While there are 1.6 billion Muslims in the world which underscores the potential for growth in Islamic finance, the market place is fragmented. One of the challenges the Islamic industry faces is a lack of consensus regarding the interpretation and application of Shariah principles, resulting in products and transactions that are valid in one country or region but not another.
Goldman Sachs was recently caught in a debate about how Shariah-compliant its $2bn Islamic bond programme is. Goldman Sachs’ sukuk programme, blessed by eight of the world’s top scholars, is criticised by some Islamic advisers for not ensuring the debt will be traded at par value as mandated by Islamic law.
The debate highlights the struggle of Islamic finance’s standard-setting bodies to formulate rules that apply globally. Companies and governments aren’t bound by the regulations set by organisations including Manama-based Accounting & Auditing Organization for Islamic Financial Institutions and Kuala Lumpur-based Islamic Financial Services Board.
Malaysian government’s Capital Market Masterplan 2 recognised the global issues and challenges. The country has laid out plans to increase cross-border collaboration, internationalise its stock market and to further develop Shariah legal, regulatory and governance framework to help its goal to become a global Islamic financing hub.
“The next phase of growth of the Islamic capital market will be characterised by greater internationalisation which entails, among others, a growing number of product issuers and service providers expanding beyond their home market, more investors seeking products or instruments with international exposure, as well as greater diversity in terms of currencies used in issuing Shariah-compliant instruments,” Zainal Izlan Zainal Abidin, executive director of Islamic Capital Market of Securities Commission Malaysia said at a conference in June.
Globally, efforts have been made through the creation of the tahawwut (hedging) master agreement in 2010, which sought to bridge Islamic and conventional markets as a major step towards standardisation of contracts and Shariah-compliance rules.
As part of a plan to cater to the diverse principles undertaken by scholars in different regions, Malaysian plans to promote a shift in approach from Shariah-compliant to a Shariah-based Islamic capital market.
“There is a need therefore to focus on product innovation and development efforts that will provide a comprehensive array of Shariah-based products for the industry,” according to the Capital Market Masterplan 2 document posted on the country’s securities commission’s website. “Towards this end, there will be further development of the Shariah legal, regulatory and governance framework.”