Keynote Address by Zainal Izlan Zainal Abidin

Executive Director, Islamic Capital Market

Securities Commission Malaysia

at the

2nd International Shariah Investment Convention 2012

Tuesday 20 March 2012

Cairo, Egypt

Introduction & Overview


Please allow me to start by extending my sincere appreciation to Amanie Advisors for inviting me to speak at this 2nd International Shariah Investment Convention. It is truly an honour to be able to address such a distinguished audience on a subject matter that is very close to the Securities Commission Malaysia, and indeed I am very happy to share the Malaysian experience in developing the Islamic capital market as well as some views on its growth potential with you today.


Islamic finance has been a remarkable growth story especially over the past decade. With average growth of about 15% per annum globally during this period, notwithstanding the global financial crisis, and an estimated size of just over USD1 trillion presently, Islamic finance has expanded in breadth and depth in many aspects including its range of products and services, the number and diversity of its stakeholders, its infrastructure and capabilities, and its geographical reach.


During this period, the range of Shariah-compliant products has broadened from those introduced merely to address the issue of riba or interest, to instruments that have been developed to cater to differing needs and users, such as Islamic investment funds and participatory instruments. In recent years, the world has also witnessed a number of multinational conventional-based financial institutions embarking into Islamic finance activities, for instance in the areas of fund management and sukuk advisory, while global companies have elected to issue sukuk instead of or in addition to conventional bonds, to raise financing for their business requirements.


At the same time, several countries have introduced legislative and tax changes to provide a level playing field for Islamic finance transactions vis-a-vis the conventional market. Furthermore, some countries that are deemed to be non-traditional jurisdictions for Islamic finance either have expressed strong interest to expand their financial industry to include Islamic finance or have actually begun to do so.


In Malaysia, Islamic finance has achieved tremendous progress. From the establishment of the first Islamic bank in the country in 1983, the Malaysian Islamic finance industry has developed very steadily over the years to expand beyond its shores and achieve the international leadership position it is firmly occupying today.


As one of the key segments of the Islamic finance industry, the Islamic capital market has played a crucial role in the overall growth of Islamic finance in the country. Malaysia’s Islamic capital market recorded a 13.6% annualised growth rate over the ten-year duration of the First Capital Market Masterplan – expanding from RM294 billion (USD95 billion) as at end-2000 to RM1.05 trillion (USD340 billion) as at the end of 2010.


The Securities Commission Malaysia believes that this growth momentum is sustainable. Under the current Second Capital Market Masterplan, the Islamic capital market in Malaysia is projected to grow further at an average rate of 10.6% per annum over the ten-year period to 2020, to take its value to RM2.9 trillion (or almost USD1 trillion) by the end of year 2020.
Historical Development of ICM in Malaysia


If I could briefly go back to recent history – the establishment of the Pilgrims Fund Board in 1969 has been widely credited as one of the catalysts for the development of the present-day Islamic finance industry in Malaysia, as it created a clear need for Shariah-compliant instruments and vehicles to mobilize the savings in the Fund towards productive economic activities in order to generate returns for the members or depositors.


From a more formal perspective, the introduction of the Islamic Banking Act and the Takaful Act in 1983 and 1984 respectively paved the way for a more structured development of Islamic finance as it provides specific legal framework for Islamic financial institutions to operate within.


The Islamic capital market in Malaysia began to make significant presence in the 1990s as demand for Shariah-compliant products and services for capital raising and financing, investment and liquidity management intensified. The world’s first Ringgit Malaysia corporate sukuk was issued in 1990 by a Malaysian subsidiary of the Shell group, and the first unit trust fund to be recognised as Shariah-compliant in the country was launched in 1993. In addition, some of the large domestic institutions started appointing fund management companies in the mid-90s to manage equity portfolios based on mandates that comply with Shariah requirements.


The year 1996 witnessed a highly important, and ground breaking, progress when the Shariah Advisory Council of the Securities Commission was established to provide Shariah rulings pertaining to Islamic capital market products and services in Malaysia. In this regard, one of the key early contributions of the Shariah Advisory Council was the development of the Shariah screening methodology for public listed companies which has led to the periodic issuance, since 1997, of the list of Shariah-compliant securities. This development has contributed to the broadening of the Islamic equity capital market, especially in respect of Islamic fund management activities and expansion of the investor base.


Another significant milestone in the development of the Islamic equity market is the launch by the Malaysian stock exchange, then known as the Kuala Lumpur Stock Exchange, of its first Islamic equity index – the KLSE Shariah Index – in 1999. This launch, which followed the introduction of an Islamic equity index under a private sector initiative several years earlier, provides investors and other market participants with a performance benchmark specifically for Islamic equities, thus enabling more robust and effective measurement of investment performance which is essential for an orderly development of the Islamic equity and fund management segments.

Building Blocks for ICM


The key value proposition that has helped to drive the rapid development of Malaysia’s Islamic finance industry is its comprehensiveness which, in turn, is a result of a meticulously planned and carefully crafted long term national strategy that has taken into consideration a wide range of critical factors that would contribute towards its viability, vibrancy and sustainability.


In this regard, with Islamic capital market having been identified as one of the strategic areas for development under the first Capital Market Masterplan from 2000 to 2010, a more holistic approach was undertaken to broaden and deepen the Islamic capital market through the implementation of a set of strategic initiatives that focused on strengthening the necessary legislative and regulatory framework, as well as enhancing the relevant infrastructure and capacity.


A facilitative and clear regulatory framework is essential in promoting an orderly growth of the Islamic capital market as it provides a conducive and sound foundation for product development and service intermediation, while ensuring a robust market supervision regime in order to sustain investor confidence and encourage broader market participation.


The International Organisation of Securities Commissions or IOSCO, in a 2004 report, stated that the conventional securities regulation framework and principles equally apply to the Islamic capital market, with the addition of some form of a Shariah approval or certification process, therefore there was not a need to formulate separate regulatory principles for the Islamic capital market. By extension, IOSCO’s objectives and principles of securities regulation – which emphasize on the protection of investors, ensuring that markets are fair, efficient and transparent, and the reduction of systemic risks – can be applied to the Islamic capital market.


Malaysia adopts a two-tier approach in regulating the Islamic capital market, which has proven to be efficient and effective. The first-tier universal or general regulatory requirements which all capital market products – conventional and Islamic – are subjected to, are supplemented by the second-tier specific Shariah-related requirements that apply exclusively to ICM products. In certain areas where these specific requirements are relatively more extensive, separate guidelines have been introduced, for instance the Islamic Securities Guidelines (for Sukuk), Guidelines on Islamic Real Estate Investment Trusts and Guidelines on Islamic Fund Management. This approach ensures that investors of ICM products enjoy the same degree of certainty, clarity and regulatory protection as those investing in conventional products.


A robust Shariah governance framework represents another key element of an orderly Islamic capital market as the requirement for its products and services to adhere to Shariah principles creates a need for an effective mechanism to ensure their adherence. In Malaysia, the national-level Shariah Advisory Council of the Securities Commission – established under an Act of Parliament and whose members are appointed by His Royal Highness the King of Malaysia – serves as the highest authority that issues Shariah rulings pertaining to the Islamic capital market in the country. This provision ensures greater certainty and consistency on Shariah-related matters for industry participants and allows them to operate on a common Shariah platform.


The Securities Commission also requires companies that issue or offer ICM products, such as Islamic funds and sukuk, to appoint Shariah committees or Shariah advisers to advise on, review and endorse the compliance of these products with Shariah principles.


Similarly, companies licensed by the SC to offer solely Islamic capital market services such as Islamic fund management companies are required to appoint Shariah committees or advisers to provide advice and ultimately certification that the companies are operating and being managed in accordance with Shariah principles.


To ensure proper and timely advice to the industry as well as to facilitate regulatory reach, the Shariah committees and advisers that are appointed in relation to ICM products and services offered in Malaysia must be registered with the SC under the Registration of Shariah Advisers Guidelines, which include stipulations on general roles and responsibilities, fit and properness, academic qualification and experience, and requirements for continuous professional development.


The pace of development of the Islamic capital market is also dependent on having a facilitative legal framework. In this area, the Malaysian laws have been and continue to be reviewed for the purpose of introducing legislative changes to remove legal impediments to Islamic finance transactions in Malaysia and to achieve greater certainty and enforceability in respect of Islamic finance contracts.


In addition, the Law Harmonisation Committee was established in 2010 to further strengthen the legal system and infrastructure in Malaysia to cater for the continuing development of Islamic finance, by reviewing relevant existing and new laws with the objective of harmonising those laws to be Shariah compatible, and in turn making Malaysian laws the reference law for international Islamic finance transactions.


Furthermore, the Shariah Advisory Council of the Securities Commission has been empowered to make rulings on any Shariah matter relating to the Islamic capital market referred to it by the courts. The binding effect of such rulings addresses the issue of uncertainty in respect of dispute resolution on contracts and transactions based on Shariah. The Shariah Advisory Council of the Central Bank of Malaysia also has similar powers in respect of Islamic banking and takaful.


Malaysia’s tax framework which provides neutrality between Islamic and conventional capital market transactions, where ICM transactions do not attract higher tax liabilities, has also been instrumental in spurring the growth of the Islamic capital market in the country, as it ensures viability in undertaking ICM transactions. For sukuk issuers, there is a significant added advantage of attracting a wider subscriber base to include investors who prefer or need to invest in Shariah-compliant instruments, resulting in more competitive pricing relative to issuing a conventional bond.


A range of tax and other incentives further support the growth of the various segments of the Islamic capital market in Malaysia, in addition to encouraging the development of innovative instruments. In the sukuk segment, incentives for issuers among others include tax deductions on issuance-related expenses and for using certain structures such as wakalah, stamp duty exemptions and flexibility to swap issuance proceeds into foreign currencies. Investors benefit from tax exemption on profits received from investing in sukuk, while intermediaries receive tax exemption on certain fees and profits earned in relation to the arranging, underwriting, distribution and trading of non-ringgit sukuk issued from Malaysia.


In fund management, Islamic fund management companies are allowed to be wholly owned by non-Malaysian shareholders in order to attract global fund management houses to establish Islamic fund management subsidiaries in Malaysia and to make these subsidiaries their hub for their global Islamic fund management activities. These Islamic fund management companies are also permitted to invest up to 100% of their assets under management in non-Malaysian securities. This allowance is to enable these companies to offer a broader range of Islamic fund management services and capabilities to both domestic and foreign investment clients. Furthermore, management fees received by all licensed fund management companies in Malaysia for the management of Shariah-compliant investment portfolios and funds are tax-exempt until 2016.


One of the prerequisites for a vibrant Islamic capital market is the presence of an extensive range of products and services with a diverse group of market participants. Having depth and breadth in terms of products and services enables the industry to cater to the demand and requirements of a wider market, while diversity of market participants ensures a more competitive industry landscape that promotes greater efficiency and innovation.


In this context, Malaysia probably has the most comprehensive range of ICM products -Shariah-compliant equity securities, where about 89% of companies listed on the Malaysian stock exchange are Shariah-compliant, sukuk, Islamic unit trusts, exchange traded fund and real estate investment trusts, to name a few. At the same time, Malaysia is home to 16 licensed Islamic fund management companies and one full-fledged Islamic stock-broking company. In addition, there are over 30 fund management and six stock-broking companies that offer Islamic fund management and stock-broking services respectively alongside their conventional businesses.


Malaysia also offers a selection of investment banks, legal firms and Shariah advisers that possess structuring and advisory capabilities for ICM products such as sukuk. Furthermore, Malaysia has an extensive representation of Islamic banks and takaful operators that play a synergistic role with their Islamic capital market counterparts.


Notwithstanding all these building blocks that are key to the development of the Islamic capital market, the most critical success factor for Malaysia is the firm commitment of the government towards positioning Malaysia as an international Islamic financial centre. In working towards this objective, the government has been instrumental in facilitating the development of the relevant infrastructure for the Islamic finance industry and in incentivising Islamic finance transactions and activities.


In line with this, the Malaysia International Islamic Financial Centre, which is supporting this event, is an initiative that is represented by the country’s regulators, government ministries and agencies, industry players and other relevant organisations, with the primary aim of attracting international institutions to use Malaysia as a platform for their Islamic finance transactions and activities.

Malaysia’s Achievements in ICM


In tandem with its substantial progress over the years, the Malaysian Islamic capital market has played a leading role in pioneering the development of ICM products and services. These include the first listed Islamic real estate investment trust (Islamic REIT) in the world and the first Islamic exchange traded fund (Islamic ETF) in Asia. In addition, Malaysia is the only jurisdiction to issue specific licence to companies undertaking solely Islamic fund management activities, and the first to establish an international Shariah-compliant commodity trading platform, Bursa Suq al-Sila’, to facilitate liquidity management of Islamic financial institutions.


Malaysia is also the global leader in sukuk. In 2011, which was a record year for sukuk issuance globally with total value of USD92 billion, Malaysia accounted for 73% or USD67 billion of the total. Malaysia is also the domicile for 68% of the USD210 billion total sukuk outstanding globally as at end-2011.


Adding to the many firsts in sukuk origination recorded by Malaysia over the years is the latest exercise by Khazanah Nasional, Malaysia’s sovereign wealth fund and strategic investor, involving an exchangeable sukuk issue which was the first to be priced at a negative yield. This issuance also demonstrated the broadening demand for sukuk globally as 49% and 39% of the issuance size were taken up by a diverse group of European-based and Asian-based investors respectively.

Future of ICM


The Global Financial Crisis of 2008-2009 has helped to direct the international financial community to focus more intently and intensively on the virtues of Islamic finance and its viability as an alternative to conventional finance. While it remains unlikely that there will be a major paradigm shift in the near term, the very fact that a growing number of jurisdictions are displaying keen interest augurs well for the future of the Islamic finance industry. Furthermore, given that Islamic finance presently still accounts for a very small percentage of global financial assets, even a modest allocation of financial transactions and activities to Islamic finance by the conventional players can generate significant growth potential for the overall Islamic finance industry.


As reflected in the growth projection for Malaysia’s Islamic capital market under the Second Capital Market Masterplan, the Securities Commission believes that the long-term potential for the Islamic capital market remains promising, not only in Malaysia but also internationally. In fact, the projections under the Masterplan are premised largely on the Islamic capital market achieving greater internationalisation.


Achieving greater internationalisation is envisaged to include several key strategic measures, such as facilitating the expansion of domestic players and intermediaries into other markets, establishing linkages with other regulators and jurisdictions, nurturing growth of high value-add segments like private equity and venture capital, as well as strengthening product innovation and development capabilities.


For the Islamic capital market to expand its global reach, it is imperative to establish and enhance international linkages to facilitate cross border transactions. Governments and regulators have a role to play in providing a conducive platform for market participants to undertake ICM transactions in an orderly manner. In this regard, challenges in having different legal, tax and regulatory frameworks across various jurisdictions would need to be addressed.


At this point, I believe it is appropriate to highlight the roles of the multilateral organisations in the context of facilitating greater internationalisation of the Islamic capital market. The Islamic Financial Services Board (IFSB), the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) and the International Islamic Financial Market (IIFM) are among these organisations that have contributed significantly to the enhancement of the global Islamic finance industry through the development of standards and guidelines that serve, among others, to strengthen Islamic financial institutions and to facilitate cross border Shariah-related transactions as well as comparability.


Opportunities involving cross border transactions and activities, and for potential collaborations among industry players across jurisdictions, are numerous, and I will highlight three of them. First, capital raising to fund large infrastructure projects can be undertaken through a global or regional sukuk issuance to tap on pools of liquidity that are seeking Shariah-compliant instruments. Such issuance will also provide diversification benefits for both the issuers and the investors.


Second, provision of Islamic fund management products and services across jurisdictions will enable the investment managers to expand and broaden their businesses and meet the demands of fund owners who seek potential for more diversified investment opportunities and better returns. In this regard, the Securities Commission has entered into mutual recognition agreements with several of our counterparts to facilitate cross offering of Islamic funds in the respective jurisdictions.


Third, demand for investment vehicles that comply with Shariah principles to cater to growing cross border investment flows will spur the development of certain capital market structures, such as Islamic private equity and venture capital.


In short, greater internationalisation of the Islamic capital market is achieved when industry stakeholders have the ability to offer and invest in ICM products and services virtually without restrictions across borders. Eventually, this will drive the quantum leap of the Islamic capital market, thus putting it firmly and undoubtedly in the global mainstream.


Mainstreaming Islamic capital market into the global capital market also requires the offering of value propositions that apply beyond religious boundaries. In this regard, the underlying principles and values of the Shariah are very much in line with ethical and socially responsible values espoused by some conventional global investors, thus providing substantial opportunity for ICM products and services to be offered and attract a wider international investor base.


Additionally, returns or investment performance represents a major consideration for investors in ICM products and services. In this respect, if we use the Dow Jones Islamic Market indexes as a proxy to the performance of Shariah-compliant equities, seven of the eight broad-market indexes under this Islamic Market Global index series outperformed their conventional equivalents over one, three, five and ten year-periods up to 31 December 2011, thus dispelling a common market misconception that Islamic investments typically underperform conventional ones due to the Shariah screening criteria.

International Collaboration


In striving towards further development of and stronger linkages within the global Islamic finance industry, there are also several other main areas for jurisdictions to collaborate on.


In the area of capacity building, which includes creating and enhancing awareness and understanding of the Islamic capital market, joint programmes such as international conferences and seminars for diverse and broad stakeholder groups are effective means of achieving the objectives. Roundtables and workshops, on the other hand, can provide a more focused approach for smaller and targeted groups to deliberate on specific issues.


Malaysia has consistently undertaken a number of capacity building programmes over the years to support the sustainable growth of the Islamic finance industry, and I would like to mention a few of these today. One such programme that is regularly organised by the Securities Commission is the Islamic Capital Market Graduate Training Scheme, a seven-week training course for recent graduates to gain greater understanding of the fundamentals of Islamic capital market products and services. To-date, over 200 graduates have participated in this programme which is now in its sixth session. A measure of success of this programme is the fact that most of these graduates manage to secure jobs with various institutions upon, and in some cases prior to, completion of the course.


Another programme is collaboration between the SC and the Oxford Centre for Islamic Studies of the University of Oxford to provide an international platform for intellectual discourse to bring about greater awareness and understanding of Islamic finance issues amongst scholars, regulators, industry practitioners, academia and investors globally. The result has been the highly successful annual SC-OCIS Roundtable – where the third Roundtable was just held last week in Kuala Lumpur.


The International Centre for Education in Islamic Finance or INCEIF is a graduate level academic institution in Malaysia that focuses solely on Islamic finance. With a distinguished faculty and a diverse international student body, INCEIF is contributing significantly to building and enhancing the human capital resources and expertise in the Islamic finance industry.


Malaysian entities in this regard would be happy to explore potential collaborations with Egyptian counterparts in this broad area of capacity building.


Another opportunity for jurisdictional collaboration to enhance international linkages is in the area of Shariah. As most of us are aware, differences in Shariah interpretations have been one of the challenges facing this industry. For this, the sharing of the rationale for Shariah rulings or interpretation across jurisdictions can create better awareness, and hopefully appreciation, within the industry. In this respect, international Shariah scholars and advisers who sit on Shariah boards and committees of financial institutions in different jurisdictions can serve to bridge the gap through constructive discussions during the course of discharging their duties.


Extending this initiative further, collaboration on Shariah research will provide a platform to address some of the main issues in Shariah, which in turn can reduce limitations on cross border Islamic capital market activities arising from any differences across jurisdictions.


Last but not least, Malaysia as an international Islamic finance hub and being centrally located within Asia, acts as a logical and effective gateway to the rest of Asia for industry players in Egypt and other countries in this region.



In conclusion, I wish to urge all participants in the Islamic finance industry to foster greater collaboration and seek ways to overcome significant disparity across jurisdictions in order to create an effectively borderless environment for Islamic finance.


While we acknowledge the different stages of development of the Islamic finance industry across the various jurisdictions, it is highly constructive for all these jurisdictions to share information so that the newer markets can take advantage of the learning process of those that have embarked on this journey much earlier, and therefore minimise the pitfalls of venturing into a relatively new frontier.


On that note, I wish everyone a successful convention, and thank you for your attention.