Malaysia Promotes Islamic Finance: US Firms Concerned

UNCLAS SECTION 01 OF 02 KUALA LUMPUR 001429

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SIPDIS
E.O. 12958: N/A
TAGS: ECON EFIN EINV MY
SUBJECT: Malaysia Promotes Islamic Finance: US Firms Concerned
over Governmental Preferences

REF A: Kuala Lumpur 1106
REF B: Kuala Lumpur 1317
REF C: Kuala Lumpur 1404


1. (U) Summary: Demand for Islamic financial paper continues to
outstrip supply, due in large part to the growing interest of Middle
East petrodollar holders to park their money in Sharia compliant
instruments. The biggest success story to date is the Islamic bond
(sukuk),the only product Islamic scholars from different parts of
the globe have reached consensus on regarding their permissibility
under Islamic law. The Government of Malaysia (GOM) continues to
push for global consensus on a wider range of Islamic products and
it is implementing regulatory and tax preferences for firms offering
such products in an effort to make Malaysia a global hub for the
industry in this growing niche market. As part of the GOM promotion
effort, Malaysian Central Bank Governor Dr. Zeti Aziz has agreed to
be the keynote speaker (see para 7) at a conference on Islamic
Finance organized by the American-Malaysian Chamber of Commerce in
Washington this October. Private sector views on the potential for
Islamic finance are mixed but some U.S. firms have expressed concern
that the GOM's preferential policies are creating an uneven playing
field in Malaysia's financial market. End summary.


Lack of Consensus on Sharia Compliance
is a Major Constraint
--------------


2. (U) A primary constraint in developing the Islamic finance
industry is the lack of consensus among Islamic scholars from the
Middle East and Southeast Asia on what is permissible under Sharia
(Islamic law). Two fundamental differences account for the main
barriers between how Islamic finance is practiced in Malaysia vs.
the Middle East: the selling of debt instruments and the mingling
of conventional and Islamic funds.


3. (U) In Malaysia, Islamic scholars have accepted the practice of
selling a debt instrument, while Middle Eastern scholars have
determined that this is forbidden. In the Middle East, a bank
practicing both conventional and Islamic finance conducts both types
of business off the same balance sheet. In Malaysia a conventional
bank engaging in Islamic finance is required to maintain a separate
"window" with a separate set of books.



The Islamic Bond: No Secret about its Success
--------------


4. (U) The concept of an "Islamic bond," however, has been accepted
as Sharia-compliant by Islamic Scholars in both Southeast Asia and
the Middle East. In fact, it is the only Islamic financial product
on which consensus has been reached. This consensus is widely
credited for driving demand for it through the roof. For example,
earlier this year Khazanah, a Malaysian government-owned investment
corporation, decided to offer a US$600 million equity-linked Islamic
bond denominated in U.S. dollars. The bond was thirteen times
oversubscribed; subsequently Khazanah decided to increase the amount
on offer by 42% to US$850 million (REF A),with fifty percent of the
issuance allocated to investors from the Middle East.


Building Consensus on Other Islamic Principles
-------------- -


5. (U) Recognizing that consensus on Sharia compliance will be
essential to developing this niche market, the GOM has established
the Malaysian International Islamic Finance Center (MIFC) which
includes a board of Islamic scholars from an array of different
Muslim-majority countries. The GOM sponsors board meetings in
Paris, London, and elsewhere in an effort to encourage
consensus-building on Sharia compliant financial instruments.
Central Bank Governor Dr. Zeti Akhtar Aziz told U.S. Ambassador
Lafleur that she expected broad consensus among Southeast Asian and
Middle Eastern Sharia scholars within two years (REF B). Consistent
with the GOM's effort to promote Islamic finance, Central Bank
Governor Dr. Zeti has agreed to deliver the keynote address at a
conference in Washington, D.C. on October 18 entitled "Islamic
Finance in Southeast Asia: Local Practice, Global Impact."


Malaysia's Federal Budget Delivers

KUALA LUMP 00001429 002 OF 002


More Favors for Islamic Finance
--------------


6. (U) The GOM is also using its Federal Budget Proposal for 2008,
released September 7, to introduce provisions designed to promote
Malaysia as a hub for Islamic Finance. These include:

-- Non-resident experts in Islamic finance will be exempt from
income tax, subject to verification of their credentials by the
Malaysian International Islamic Financial Center (MIFC). This is
designed to attract more talent from countries in the Middle East,
many of which do not impose income tax. (This provision was
championed by Citibank Malaysia which engages in both conventional
and Islamic finance.)

-- An existing tax exemption for management fees for Islamic funds
for foreign investors will be extended to Islamic funds managed for
local investors as well.

-- Tax exemptions for issuers of Islamic Financing through Special
Purpose Vehicles will be expanded.

-- Specific tax provisions for Islamic insurance (takaful) operators
will be introduced.


Players Get Energized
--------------


7. (U) With such strong GOM encouragement, interest in Islamic
finance is accelerating in Malaysia. On September 17 Bank Islam
Malaysia signed a strategic partnership with London-based European
Islamic Investment Bank PLC, according to press reports. The
partnership is intended to link up the European and Asian markets
for financial products that are compliant with the principles of
Sharia (Islamic law). Bank Islam Managing Director Zukri Samat told
reporters the bank planned to bid on arranging several Islamic bond
issues, including one for US$300 million jointly with its new
partner.

Conventional Finance Being Crowded Out?
--------------


8. (SBU) Brad Bennett, CEO of American Home Assurance Company
Malaysia, a wholly-owned subsidiary of U.S.-based American Insurance
Group, told ECONOFF he was concerned that preferential regulatory
treatment of Islamic Insurance (takaful) was crowding out
conventional insurance products in Malaysia. The company had
applied for a license to do Islamic insurance in Malaysia, but has
yet to receive approval. Meanwhile, customers are switching, he
said. On August 29, Central Bank Deputy Governor Zamani Abdul Ghani
invited applications for reinsurance licenses (REF C).


9. (SBU) Citigroup Malaysia CEO Sanjeev Nanavati expressed similar
concerns, saying the GOM's special concessions and incentives for
Islamic finance gave its practitioners an unfair advantage. But
Citi continues to believe Islamic finance faces so many obstacles
that it will continue to struggle, even with GOM support.


10. (U) Comment: The Government of Malaysia is determined to make
the country a global hub for the industry and thereby maintain the
leading edge its financial firms currently possess in this growing
niche. Moreover, it is coming through with the funding, the
political pressure, and the regulatory and tax advantages to smooth
development for financial companies in this highly regulated
economy. Obstacles and opportunities in this niche market will be
reviewed septel.