Keynote Speech
YBhg Dato Dr Nik Ramlah Mahmood
Deputy Chief Executive, Securities Commission Malaysia
at the

IFN Asia Forum 2015 Tuesday, 26 May 2015

Facilitating Innovation in the Islamic Capital Market

1. Let me first thank IFN for inviting me to speak at this flagship IFN Forum 2015. I am pleased to note that this event has over the years grown from strength to strength and is now a key event in the calendar of the global Islamic financial services industry.
2. Typically innovation in the global capital markets or the financial services industry is driven by the industry, by the forces of demand and supply. The size of global financial assets which currently stands at USD305 trillion and is more than four times world GDP (USD75.6 trillion) reflects the frenetic pace of innovation in the financial markets. Overall these innovations have resulted in the increasing variety and diversity of products and services and more innovative distribution channels, thus offering more choices, lower costs and better returns for investors and issuers. This process continues in the pursuit of the ever growing commercialisation of financial products and services.
3. Unlike in nascent or developing markets where regulators typically have the legal mandate to facilitate market development, in developed markets, policy makers and regulators do not need to provide a helping hand to facilitate innovation. That is until and unless the innovation in the market causes harm to the investors, threatens the fair and orderly operation of the market or poses systemic risks. This is when regulators will take a more interventionist role in order to ensure that the objectives and principles of regulation are not compromised. We have seen many examples of this in many parts of the world, especially after the Global Financial Crisis.
4. The same hands-off stance however cannot be adopted with respect to the Islamic financial services industry and more specifically the Islamic capital market (ICM). Policymakers and regulators, whether in developed or developing markets, have a significant, indeed crucial, role in developing the market and facilitating innovation. There are several reasons for this – the obvious one being the fact that the ICM, unlike the conventional market is still in a state of relative infancy. Additionally, facilitating growth and innovation in the ICM often involves numerous complexities such as regulatory, legal, tax and Shariah aspects that cannot be resolved just by the industry. It is fair to say that in Malaysia, the size of our ICM could not have reached RM1.64 trillion as at end April 2015, without the government, regulators, the shariah experts and others working together with the industry to facilitate innovation.
5. Over the last decade, the ICM has witnessed numerous innovations whether in the form of products, services or market infrastructure. However many of these involve replicating and adapting what is available in the conventional space to make them Shariah-compliant. Whilst such innovations have to a certain degree served industry needs, this may not be sustainable as market demand and expectations evolve.
6. To be sustainable, the appeal of the ICM cannot be based only on liquidity, competitive cost of capital or returns on investment. For instance while currently sukuk represents an efficient means to tap capital in several countries including Malaysia, when it becomes cheaper to tap the conventional bond market, issuers who are guided solely by considerations of costs and liquidity are likely to shift there. Similarly, if Islamic funds are sold solely on the basis of competitive returns, a period of lower returns could see investors shift their investments to conventional funds.
7. To develop ICM in a manner that differentiates it from the conventional market and put it on the path of sustainability, many aspects of innovation must be pursued.
8. The first is innovation to keep pace with the level of sophistication in the global financial market. This is intended to ensure ICM remains viable, relevant, competitive and continues to meet the demands of issuers and investors. This is financial innovation which has seen the introduction of many Shariah-compliant products serving diverse investors. Financial innovation is usually pursued by the industry with little if any need for facilitation or incentives as the innovators themselves will reap the benefits from their innovation. Recent examples of such innovation include Basel III’s Tier-1 and Tier-2 compliant sukuk.
9. As we are all aware there has been growing calls for Islamic finance to embrace the true objectives of Shariah (Maqasid al-Shariah). The second aspect of innovation is therefore to ensure that ICM embraces and is built on the core values embedded in the Maqasid al-Shariah. ICM products and services should therefore incorporate sustainable values towards the environment and society, ensuring financial products are financially inclusive and incorporating environment, social and governance (ESG) principles. This includes making ICM accessible to a larger segment of society especially those with limited access to savings, investments and financial services. ICM products such as Islamic unit trusts and retail sukuk can serve as a catalyst to achieving financial inclusion by enabling greater retail investor participation. Additionally SME and micro financing should be facilitated as SME financing remains a critical challenge in most markets.
10. Another aspect of innovation is the need for Islamic finance to be linked to the real sector especially through wider use of risk-sharing structures. Financing that is linked to the real sector allows Islamic finance to be differentiated from conventional finance. More work needs to be done so that risk-sharing structures can be made more appealing to investors. Key stakeholders must take pro-active actions to incentivise risk-sharing structures.
11. The role of Shariah scholars and experts in facilitating innovation in ICM is critical. Innovation in the ICM cannot be achieved without their strong support and pronouncements with respect to the application of the guiding principles in fiqh muamalat to financial products and services. Shariah advisers, experts and Shariah research institutions all play a role in contributing to the Islamic financial industry. Shariah councils or committees and supporting research institutions have often demonstrated their ability to proactively issue various guidance or research findings for the industry to pursue in terms of new product development.
12. The issuance of the innovative stapled security REITs of KLCC Property Holdings Bhd, is a fine example of how the Shariah Advisory Council of the SC has been most responsive in issuing the relevant Shariah rulings to facilitate the introduction of the world’s first Islamic stapled security. In this case each component security, i.e. the REITs units and ordinary shares, must be Shariah compliant based on the Guidelines for Islamic Real Estate Investment Trusts and equity screening methodology respectively. Similarly, the SAC has issued Shariah Parameters on Islamic Exchange-Traded Fund (i-ETF) based on gold and silver that provides clarity, certainty and guidance to the industry for the development of new products. We can expect the SAC to issue more of such Shariah parameters to facilitate innovation in the ICM in the future.
13. To complement the work of our Shariah Advisory Council, the Securities Commission, given our legal mandate to develop the capital market, facilitates innovation in the ICM through the introduction of frameworks and regulations for products and services, reviewing and amending existing regulations and laws or the introduction of new ones.
14. One area where SC had played a prominent role in facilitating innovation is in the promotion of sustainable and responsible investment (SRI). The Capital Market Masterplan 2 (CMP2) first identified the importance of sustainability and recognized that the role of the capital market can be expanded to support this agenda by providing market-based solutions that will bring scale and financial discipline in mobilising investments to companies, projects and products that promote sustainable development.
15. Pursuant to this in August 2014 the SC introduced the SRI Sukuk Framework within the Sukuk Guidelines to facilitate the financing of sustainable and responsible investment initiatives. In coming out with the framework, the SC had engaged various stakeholders at all levels, from the Ministry of Finance (on the tax incentives) to other industry stakeholders including potential issuers. Engagements through roundtable discussions and industry dialogue were held in the course of formulating the framework.
16. But guidelines without actual issuance will not bring about innovation in the ICM. It is thus most heartening to note that earlier this month Khazanah Nasional Berhad has announced a RM1 billion Sukuk Ihsan Programme as the first social impact sukuk in Malaysia. Khazanah will use the proceeds to fund selected Government schools under Trust Schools Programme, with clear key outcomes that are linked to SRI-based “step-down yield” mechanism with the sole aim of enhancing the quality of government-run schools.
17. The Shariah compliance and governance aspects of the SRI Sukuk framework were carefully crafted so as to ensure the universality of its application. In this regard, the Shariah Advisory Council of the SC (SAC) played a significant part in facilitating and supporting Shariah innovation. The very fact that proceeds from the issuance of an SRI sukuk can also be channelled towards developing waqf assets reflects the foresight and wisdom of the SAC in linking SRI with socially oriented agenda benefiting the society at large.
18. Another example of how the SC has facilitated innovation is in the fund management industry. The ASEAN CIS Framework for Cross Border Offering of Funds, an initiative of the ASEAN Capital Markets Forum, allows collective investment schemes (CIS) including Islamic CIS to be distributed in three participating countries namely Malaysia, Singapore and Thailand. The Islamic fund management industry is expected to greatly benefit from this by having access into new markets. The recent launch of the first Islamic equity fund under the Framework – Maybank-Bosera Greater China Asean Equity-i-Fund – by Maybank Asset Management in partnership with Hong Kong-based Bosera Asset Management is the first Islamic product offered under the framework and should be a precursor to more innovative cross-border offerings. We consider this a significant development in the ICM as it offers tremendous growth opportunities for Malaysia’s capital market service providers.
19. Innovation is key for the ICM to continue on its growth trajectory. Such innovation may involve financial, social or Shariah aspects but one thing is clear, all stakeholders, policymakers, regulators, Shariah experts and industry must work together to facilitate the innovation.

Thank you.