Malaysia’s fast-growing Islamic bond market is luring investors that are less experienced with such structures, enabling domestic borrowers to price these shariah-compliant notes tighter than conventional offerings.
Hedge funds and fixed-income funds are among those emerging as significant buyers of the Southeast Asian nation’s Islamic bonds, or sukuk, which have been traditionally bought by Muslim investors seeking assets that adhere to shariah law.
“Most Malaysian issuers will typically opt for sukuk issuances if the nature of business of the issuers allow them to do so,” said Thomas Meow, head of credit markets at CIMB to FinanceAsia. “Sukuk issuances are able to attract a larger pool of investors as both conventional and Islamic funds are able to invest in sukuk issuances.”
"In Malaysia, investors are agnostic between conventional notes and sukuk issuances as they do not require any structure premium to be added to the pricing of Islamic issuances," he added.
For example, fund managers and hedge funds bought 42% of Malaysian Export-Import Bank’s (Mexim) $300 million five-year sukuk in February, which was the world’s first international Islamic bond of the year. Financial institutions and private banks subscribed to 30%, followed by central banks and sovereign wealth funds with 16%, insurers and pension funds with 10% and others 2%.
Additionally, Asia ex-Malaysia investors subscribed to half of the trade bank’s paper, followed by Middle Eastern investors with 19%, European 16% and the remainder to Malaysian investors, according to sources close to the deal.
Islamic bonds comply with Islam’s ban on interest payments and pay returns derived from physical assets. According to Dealogic data, sukuk account for 84% of Malaysia total debt capital market volume of $9.3 billion year-to-date, compared to 2013’s 43% of $11.4 billion during the same period.
Aside from attracting a wider investor base, sukuk issuers – more often than not – are able to price these offerings tighter than their conventional notes, Meow said.
“Islamic deals are priced either around par or slightly tighter than comparable conventional issuances because of wider investor demand which creates a scarcity value to this asset class,” he said, adding that borrowers can typically price approximately 3bp to 5bp tighter than conventional bonds.
This was also the case with Mexim’s dollar sukuk, which priced flat to its existing conventional at Treasuries plus 140bp, according to sources familiar with the matter.
Islamic bank capital
Given the buoyant demand for the asset class, Malaysian banks have begun to tap the Basel III sukuk market with AmIslamic being the first domestic Islamic financial institution to do so in February.
The bank raised its first Tier 2, worth M$200 million ($62 million), followed by a second tranche worth M$150 million in March. The sukuk offerings were priced at profit rates of 5.07% and 5.05% respectively.
“Overall, sukuks are now playing an instrumental role in addressing the liquidity and capital adequacy needs of Islamic banks as stipulated by the Basel III accords,” Meow said. “Basel III sukuk represents a significant development in shariah-compliant financial instruments, which enables Islamic banks to progress alongside their conventional peers.”
Maybank Islamic followed suit and issued a M$1.5 billion Basel III-compliant Tier 2 sukuk in April, priced at a lower return of 4.75% due to better ratings. Public Islamic and RHB Islamic have also announced similar offerings and these are in the pipeline for issuance this year.
Maybank Islamic’s sukuk is rated AA1 by Malaysia’s local ratings agency RAM Ratings while AmIslamic is rated AA3.
RAM Ratings expects $130 billion to $140 billion of new global sukuk issuance in 2014 in order to fund Malaysia and the Gulf Cooperation Council’s ongoing infrastructure development. The agency also believes that the Southeast Asian country will retain its position, with about 70%-share of the global Islamic bond market this year.