Considered the world’s largest Islamic finance hub, Malaysia has been proactive in extending the reach of Islamic bonds beyond its shores.
Since the beginning of 2015, there have been two landmark Malaysian Islamic bonds, also known as sukuk — a $5 billion multi-tranche deal from the Southeast Asian nation’s state-owned oil company Petronas and a $1.5 billion dual-tranche Islamic bond from the Government of Malaysia.
These instruments, which comply with Islam’s ban on interest and pay returns derived from physical assets, were not only sold in the Reg S market (sales made outside the US), but also in the Rule 144A market (instruments sold to onshore US investors).
Tapping both the Reg S and Rule 144A markets has become more prevalent of late — especially for entities looking to raise large amounts of Islamic finance. That is because US-based investors have been allocating a larger proportion of their funds to Islamic bonds and global banks are increasingly looking to include these securities in their benchmark credit indexes.
As Muslim populations in Asia and the Middle East intensify their demand for shariah-compliant modes of investment, US-domiciled asset management companies also have reason to embrace Islamic finance to meet investors’ needs.
So as the world’s biggest economy with historically the deepest pool of investment, the US is set to begin playing a bigger role in the development of Islamic finance, fixed income experts say.
“It is crucial to [grow] the pool of US investors who are familiar with Islamic finance and sukuk in particular,” comments Arshad Ismail, head of corporate and investment banking at Maybank Islamic. “We have been engaging and will continue to engage in discussions with policymakers and key investors in the US [to increase their awareness].”
According to Kuala Lumpur-based Islamic investment research firm KFH Research, there were eight Islamic funds operating in the US, with total assets under management of $3.9 billion, as of December 15, 2014. A further five global Islamic funds have a strong US focus with AUM totaling $3.7 billion, it adds.
Although still considered miniscule – the US bond market had total outstanding debt of almost $39 trillion at the end of 2014, according to the Securities Industry and Financial Markets Association — Islamic finance experts expect that pool of US money to grow at a pacey clip, in line with broader global trends.
The global Islamic finance industry’s assets grew at a compound average growth rate of 17.3% between 2009 and 2014, according to Malaysia International Islamic Finance Centre (MIFC) in an April report. By 2018, MIFC is projecting total assets of $3.5 trillion, up from $2 trillion at end-2014.
“The strongest potential is in asset management, as the US is a key destination of funds from the Middle East and Asia, among others,” MIFC says. “Supported by ample liquidity, private retirement funds and sovereign wealth funds from these key Islamic finance regions head to the US — and given the proliferation of Islamic finance in these jurisdictions, US-based funds may expand shariah-compliant offerings.”
Petronas made a splash on March 12 with Asia’s second-largest corporate bond after Alibaba’s mammoth $8 billion multi-tranche deal in November. The A1/A rated note — its first international deal in over five years — comprised a $1.25 billion five-year sukuk, as well as a $750 million seven-year, $1.5 billion 10-year, and $1.5 billion 30-year conventional paper.
The Government of Malaysia priced a dual-tranche Islamic bond a month later, ending its four-year hiatus in the international debt capital markets. The A3/A- rated offering consisted of a $1 billion 10-year note and $500 million 30-year tranche — the first ever 30-year dollar-denominated sukuk issue by a sovereign.
US investors subscribed to 29% of the Malaysian sovereign’s 30-year Islamic notes and purchased 10% of the 10-year paper, sources close to the deal said.
“Investors in the Rule 144A space are generally familiar with the various sukuk structures in the market and, more often than not, focus on credit-related issues when evaluating a transaction,” Ismail adds. “It also helps that the rating agencies engaged in rating such transactions are agencies that investors are all familiar and comfortable with.”
Part of the gang
With the globalisation of Islamic finance becoming more prevalent, a few global indices have also begun to include shariah-compliant assets in their baskets.
Aside from HSBC — one of the early adopters of sukuk in its HSBC Asia Local Bond Index — Barclays has now incorporated Islamic instruments into its global bond index.
On March 31, the UK lender included Malaysia’s Islamic bonds into the Barclays Global Aggregate Index, a flagship measure of global investment grade debt from 24 local currency markets. With a weighting of 0.18% in the index, the sovereign is also a constituent of Barclays’s Asia-Pacific and emerging markets local currency government indexes.
Because of this, the Southeast Asian nation is estimated to have received at least $2.5 billion to $3 billion of additional interest from international investors, enabling the country to price its Islamic bond at cheaper levels than its non-Islamic notes.
“In the past, some Islamic bonds used to command a slight premium because it was considered an exotic instrument and they attracted a smaller number of investors. Therefore, they tended to be less liquid,” Rafe Haneef, chief executive officer at HSBC Amanah, notes. “Today, the sukuk has a broader set of investor base. Not only can they target conventional investors, but they also have Islamic investors that are always short of assets.”
As of June 5, the average yield on the 10-year Malaysian sovereign sukuk was 3.19%, compared with 3.96% for conventional paper of the same maturity. Malaysia’s recent $1 billion 10-year sukuk priced at a yield, or so-called profit rate, of 3.043%.
Barclays’s index adjustments make it more likely that other lenders will follow suit by adding sukuk to their indexes, with the next potential candidate being the JP Morgan Emerging Market Bond Index, according to analysts.
That trend, together with Islamic finance’s growing footprint in non-traditional domiciles and the proliferation of bigger and more competitive deals, can only boost the appeal of Islamic funding among US and EU corporations, including Fortune 500 companies, MIFC said in its April report.
The qualifier for now, though, is that the Reg S/144A market will only remain open to high quality issuers. “Issuers need to be at least investment-grade names or BBB- onwards. Unrated issuers normally attract investors from the local or more regional markets,” HSBC’s Haneef adds.
The still-low US interest rate environment combined with growing investor appetite for Islamic finance means there is a healthy pipeline of upcoming Islamic bonds.
Malaysian issuers are keen to tap international investors to lock in lower funding costs before the US Federal Reserve makes a long-anticipated move to hike rates for the first time since 2006. So far this year, the sukuk bonds have returned 1.60% according to the Bloomberg Sukuk Market Return Index, which closed Friday at 120.09.
Telekom Malaysia could be next in line. The firm, which last sold dollar-denominated debt instruments in 1995, established a $750 million multicurrency Islamic bond issuance programme on April 24 for its special purpose vehicle, Tulip Maple Berhad (TMB), according to rating agency Fitch.
State-backed Malaysian mortgage lender Cagamas is also expected to sell up to $2.5 billion in the sukuk format under its recently established multi-currency Islamic bond programme.
“If any of those mortgage purchases come in the form of Islamic home financing, we would obviously have to do a sukuk,” Chung Chee Leong, chief executive officer of Cagamas, tells FinanceAsia, adding that the institution is in the middle of discussions with local banks to purchase some Islamic loans.
Malaysian rating agency RAM Ratings anticipates new global sukuk issuance to remain fairly resilient in 2015, with supply reaching $100 billion to $120 billion, which is somewhat similar to 2014’s total of $116.23 billion.
Malaysia remains a key marketplace for global sukuk issuance. The largely Muslim country accounted for nearly 65% of total new issuance ($94.7 billion) in the first three quarters of 2014, according to KFH Research.