Global Islamic Finance Forum: Moving beyond boundaries

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The Edge: The global Islamic finance industry is still experiencing double-digit growth, but it has slowed in the last two years as the industry consolidates in preparation for the next growth phase. What catalysts do you think will trigger the next wave of growth?

Tan Sri Dr Zeti Akhtar Aziz: Islamic finance has shown strong growth despite a challenging international environment in the aftermath of the global financial crisis. This growth is taking place in existing and new market segments as well as in new jurisdictions. In the global financial system, Islamic banking assets are now estimated to have exceeded US$2 trillion (RM6.3 trillion). In the domestic financial system, total Islamic banking assets now account for 25% of our banking system, from only 6% in 2000. The domestic sukuk market accounts for 57% of the bond market, from only 15% in 2000.

The catalysts for the next wave of growth need to come from both the public and private sectors and the regulators. From the public sector and regulators, including the international community, further supporting financial infrastructure needs to be put in place. This includes the necessary legislative framework to provide clarity and certainty for financial transactions, the payments and settlement system that supports cross-border transactions, and the regulatory and supervisory framework that is commensurate with the new developments. This will ensure the sustainability of its growth.

For the private sector, it is innovation that will [create] products that meet the new and changing financial requirements of the economy. In addition, growth will follow the entry of new markets, including international financial centres such as London, Hong Kong and Luxembourg, and other emerging and developing economies. This will contribute towards greater internationalisation of Islamic finance and provide new growth opportunities to the industry globally. Mutual respect and recognition for shariah rulings, [as well as] the adoption of international standards agreements across jurisdictions will spur the demand and acceptance of Islamic financial products and services.

Internationalisation is one of the catalysts, yet there are challenges in moving towards internationalisation. What does this mean for the industry and can proper internationalisation actually occur?

Internationalisation is already happening as the intermediation of funds now involves cross-border transactions. Evidence of this is the movement of the Islamic intermediaries to beyond their respective borders and the participation of non-residents in financial markets in different parts of the world. While banks in Malaysia have expanded their operations abroad, there has been a significant increase in foreign entrants and participation in our Islamic financial markets. This trend has facilitated the development of cross-border transactions, including through multi-currency Islamic financial transactions. New sovereign issuances have also provided vast opportunities for Islamic banks and fund managers, with new prospects for ancillary services, such as shariah advisory firms, rating agencies and IT solution providers.

Islamic banking recently experienced great strides towards increased cross-border transactions through the standardisation of documentation, including the standard master agreements issued by the International Islamic Financial Market (IIFM) for Islamic interbank transactions. Standards such as those set by IIFM will prove invaluable in streamlining such Islamic financial transactions. A more recent development is the establishment of the International Islamic Liquidity Management (IILM) and its regular issuance of short-term instruments for liquidity management of multi-currency portfolios. It will contribute towards the international diversification of risk by investors, in addition to supporting prudential requirements for liquidity management by Islamic financial institutions.

Technology and the digital age are supposed to be another catalyst. How have Islamic financial institutions embraced technology to keep abreast of global trends?

Being in a competitive industry, Islamic financial institutions will have to embrace technology advances to maximise business efficiency while maintaining shariah compliance. It will certainly be a catalyst for the industry’s growth. Apart from increasing efficiency and thus competitiveness, it will increase outreach and the potential to achieve economies of scale. It is important for the industry to work collectively to develop and share platforms that can optimise the use of such technology.

Areas in which such advancement has been achieved include the Bursa Suq Al Sila’, a designated exchange-traded platform to facilitate commodity murabahah transactions based on the collaborative efforts of Bank Negara Malaysia, the Securities Commission Malaysia, Bursa Malaysia and market players. Another example is the Thomson-Reuters Islamic Finance Gateway, a neutral platform that enables worldwide dissemination of information and discussion among Islamic finance professionals, industry standard bodies, rating agencies, index providers, consulting firms, shariah scholars and Islamic financial institutions from more than 25 countries.

Malaysia played a key role in pushing the development of the global Islamic finance industry. Today, where does it stand in relation to other key markets in this space? Is it providing the necessary leadership to take the industry forward? What more can it do?

Our vision for the development of Islamic finance was articulated in our first 10-year Financial Sector Masterplan launched in 2001. Here, the plans for building the foundation for Malaysia’s Islamic financial system were outlined. These included strengthening and diversifying the financial intermediaries in the financial system, building and developing the domestic Islamic financial markets and enhancing the regulatory, supervisory, shariah and legal framework.

The Financial Sector Blueprint, which was launched in 2011, mapped out a 10-year plan for the internationalisation of Islamic finance. This is to enhance our financial and economic linkages with other parts of the world. Opportunities come from various jurisdictions where there is strong demand for effective financial intermediation that will support the real economy.

In collaboration with other central banks and several multilateral development institutions, Malaysia continues to contribute to the strengthening of international infrastructure in Islamic finance that supports financial stability. Malaysia is honoured to host the Islamic Financial Services Board (IFSB), a standard-setting body for Islamic finance that has provided a platform for increased regulatory cooperation, encouraged uniformity of regulatory frameworks and enhanced the monitoring of financial risks in the Islamic financial system. Another milestone is the establishment of the IILM in Kuala Lumpur, which represents a collective effort to facilitate more efficient cross-border liquidity management by Islamic financial institutions.

Other pioneering efforts include product innovation, such as equity-linked exchangeable sukuk and multi-currency sukuk [such as the renminbi or Singapore dollar]. An Islamic commodity trading platform, Bursa Suq Al-Sila, was established to facilitate commodity murabahah transactions. In addition, Malaysian banking institutions have participated as joint lead managers for sovereign sukuk issuances in other parts of the world. Malaysian shariah advisory firms also have footprints around the world in Islamic finance businesses.

The Islamic Financial Services Act 2013 (IFSA) is the game changer for the industry. How is this panning out? What are the challenges in terms of compliance?

For the international expansion of the Islamic finance industry to continue, it is essential for the respective jurisdictions to develop strong and resilient domestic markets. The IFSA is part of the key steps taken to strengthen our local base to enable effective participation in the global Islamic finance industry. It is a catalyst for greater legal and operational certainty for stronger end-to-end shariah compliance. It also allows Islamic financial institutions to intermediate investments, providing a novel avenue for a more diversified Islamic banking business that can attract a wider customer base.

For this, the industry is expected to embrace the challenge of ensuring that such business diversification is undertaken in an orderly manner.

Bank Negara has set out an adequate transition period, from July 2013 to June 2015, for Islamic financial institutions to develop the appropriate products. It is now up to the industry to capitalise on and take full advantage of the opportunities presented by the IFSA. Most importantly, it will involve product innovation by Islamic financial institutions in the area of investment intermediation, in addition to their current credit intermediation offerings. This new line of business should, however, be supported by the appropriate expertise and internal system capabilities to identify and monitor the appropriate investment opportunities.

A view is that education and training courses on Islamic finance in Malaysia produce good generalists, when what companies are looking to hire are specialists. How should this be addressed?

The current Islamic finance training landscape in Malaysia provides a myriad of internationally recognised training programmes for professionals. The training providers have engaged extensively with industry players to better understand the industry’s needs and maintain the relevance of their programmes.

More top quality talent will be required, given the current trends of evolving regulatory requirements, the advancement in technology and changes in the dynamics of customer demographics. In the intermediate term, the industry can draw from the existing talent pool of specialists in the conventional sector and provide them with intensive training and exposure to Islamic finance. And, given the liberalisation of the financial sector, companies can access expatriate specialists from the global talent pool. Malaysia has been a source of such talent for other parts of the world. The flow of talent therefore has to be two-way.

Over the medium term, however, we need to aggressively develop talent for Islamic finance, including its requirement for specialists. The industry should sponsor scholarships in large numbers for education in local and foreign institutions of higher learning. The central bank has provided a significant allocation for the endowment fund in the establishment of INCEIF, the global university for Islamic Finance. The university has produced a significant stream of talent since 2005. Currently, it has more than 2,000 students from more than 80 countries.

Under Basel III, Islamic banks, like their conventional counterparts, will have to beef up their capital. Do Islamic banks generally meet the capital requirements or do you expect them to go on fundraising exercises? How would that impact the industry?

Islamic banks in Malaysia continue to be well-capitalised, as the industry transitions to the more stringent Basel III requirements. As at end-March 2014, the Islamic banking sector had a Common Equity Tier 1 capital ratio of 12.5%, Tier 1 capital ratio of 12.6% and total capital ratio of 14.8%. These positions are well above minimum regulatory requirements (4%, 5.5% and 8% respectively). Between March and June, five Islamic banks issued Basel III-compliant sukuk, while six others have similar plans for such issuances. These issuances have been a proactive measure by the Islamic banks to further strengthen their capital position to support future business expansion.

The Malaysia International Islamic Financial Centre was launched in 2006 to, among others, promote Malaysia’s Islamic finance to the world, establish links with other financial markets and secure mandates for Malaysian Islamic finance practitioners. Do you think it has met its objectives?

Malaysia’s Islamic finance marketplace is now characterised by a robust regulatory, supervisory, shariah and legal framework; a deep primary and active secondary sukuk market; an efficient price discovery mechanism; a diverse talent base with global capabilities and an efficient system for multi-currency clearing and settlement. The key components of Malaysia’s Islamic finance marketplace include Islamic banking, Islamic capital market, takaful and re-takaful, Islamic money market, professional ancillary services, talent development infrastructure, and Islamic fund and wealth management.

The goal is to be an open marketplace that is linked to other financial hubs. The openness of Malaysia’s marketplace has seen increased foreign participation, both in terms of institutional presence and participation in the financial market. This has increased our global financial and economic connectivity and integration with other parts of the world.

Efforts are now underway to enhance our inter-linkages with existing international financial centres around the world and to create new relationships with Islamic and traditional financial markets. The conducive business environment for cross-border fundraising activities, as well as for fund and wealth management activities, has drawn foreign corporates, financial institutions and investors to Malaysia to carry out their Islamic financial business and investment activities.

In the sukuk segment, Malaysia offers a multi-currency platform for international fundraising. Our total sukuk issuance in the first half of this year was about US$41.69 billion and Malaysia’s total sukuk outstanding is now at US$286.41 billion. Our sukuk marketplace is supported by a robust regulatory and supervisory framework, an efficient price discovery platform and a deep primary and active secondary sukuk market. Malaysian Islamic financial institutions have been active, as lead managers for several sovereign and corporate issuances from other parts of the world. The expertise established in the sukuk market presents opportunities for professional services firms to enhance their global capabilities.

What are your views on how the MIFC should evolve to engage the various stakeholders in the market?

The recent global financial crisis has reinforced the importance of ensuring that financial systems serve the real economy. Given that the intrinsic nature of Islamic finance requires a close linkage between the financial sector and the real economy, there is significant potential for this role in facilitating real trade and investment flows that will be mutually reinforcing. With Malaysia’s highly liberalised environment, Islamic finance has an important role in facilitating cross-border international trade and investment flows. Increased collaboration among the various stakeholders to internationalise Islamic finance is therefore important. Intensifying the connectivity with global companies and the growing economic sectors, including small and medium enterprises, as well as the mobilisation of funds for infrastructure development, will enhance the role of Islamic finance in the economy.

Upcoming sectors of the Islamic financial industry, such as Islamic wealth management and private equity, will have significant potential to grow. Further engagement with non-financial entities and ancillary services, including legal, accounting and other advisory firms and educational institutions, will be important to the effective functioning of the Islamic financial system.

Malaysia aspires to be a global sukuk hub, but there has been feedback that the ratings of foreign issuers by the local rating agencies, do not reflect their current standing, as far as their international ratings are concerned. What is your view?

All rating agencies have different methodologies for assessing the credit of potential issuers. Malaysian rating agencies are building their international stature and have gained recognition from certain foreign stock exchanges.
In addition, the liberalisation to allow the entry of international credit rating agencies is envisaged to enhance the quality and standard of rating services in Malaysia, as well as to facilitate the transfer of expertise and knowledge.   

Since last year, there have been some positive developments for Islamic finance worldwide, such as the £200 million UK sukuk and Hong Kong’s US$1 billion sukuk. How do you view these developments and what do they say about the spread of Islamic finance in the Western world and non-Muslim markets?

The reach of the industry has moved beyond geographical and religious boundaries. Islamic financial products and services are now offered in more than 70 countries. This reflects the global acknowledgement of Islamic finance, as an effective form of financial intermediation.

The UK has become the first Western country to issue a sukuk, attracting orders of more than £2 billion from global investors. It was heavily oversubscribed by investors in the UK, Middle East and Asia — 10 times higher than the amount sold. This issuance sets a precedent for the Western financial world. The high demand for quality papers is expected to encourage further issuance from Western countries and corporates. Hong Kong announced a debut sovereign US$1 billion sukuk to be issued in the third quarter of this year.

This story first appeared in The Edge weekly edition of Sept 01-07, 2014.