Identifier
Created
Classification
Origin
07KUALALUMPUR1462
2007-09-27 08:58:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Kuala Lumpur
Cable title:  

Islamic Finance in Malaysia Part 2: Obstacles and

Tags:  ECON EFIN EINV MY 
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RR RUEHCHI RUEHDT RUEHHM RUEHNH
DE RUEHKL #1462/01 2700858
ZNR UUUUU ZZH
R 270858Z SEP 07
FM AMEMBASSY KUALA LUMPUR
TO RUEHC/SECSTATE WASHDC 0029
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHDC
RUEHGV/USMISSION GENEVA 1512
RUCNASE/ASEAN MEMBER COLLECTIVE
UNCLAS SECTION 01 OF 02 KUALA LUMPUR 001462 

SIPDIS

STATE PASS USTR - WEISEL AND JENSEN
STATE PASS FEDERAL RESERVE AND EXIMBANK
STATE PASS FEDERAL RESERVE SAN FRANCISCO TCURRAN
USDOC FOR 4430/MAC/EAP/J.BAKER
TREASURY FOR OASIA AND IRS
GENEVA FOR USTR
SENSITIVE

SIPDIS
E.O. 12958: N/A
TAGS: ECON EFIN EINV MY
SUBJECT: Islamic Finance in Malaysia Part 2: Obstacles and
Opportunities

REF: Kuala Lumpur 1429

UNCLAS SECTION 01 OF 02 KUALA LUMPUR 001462

SIPDIS

STATE PASS USTR - WEISEL AND JENSEN
STATE PASS FEDERAL RESERVE AND EXIMBANK
STATE PASS FEDERAL RESERVE SAN FRANCISCO TCURRAN
USDOC FOR 4430/MAC/EAP/J.BAKER
TREASURY FOR OASIA AND IRS
GENEVA FOR USTR
SENSITIVE

SIPDIS
E.O. 12958: N/A
TAGS: ECON EFIN EINV MY
SUBJECT: Islamic Finance in Malaysia Part 2: Obstacles and
Opportunities

REF: Kuala Lumpur 1429


1. (U) Summary: Malaysia is determined to become a global hub for
Islamic Finance, and already accounts for two thirds of outstanding
Islamic bond issuances (reftel). However, at a recent conference in
KL, financial experts discussed a number of obstacles holding back
development of this niche market. Chief among them was the
inadequacy of the secondary market and the lack of Islamic
derivative products. Higher legal fees and complications arising
out of the need for Sharia compliance were a burden as well.
Nevertheless, the Malaysian government remains optimistic and
content to have a pragmatic approach to development rather than get
hung up on the need for a "purist" approach to Sharia compliance.
End summary.


Central Bank Governor Claims
40% Annual Growth in Islamic Bonds
--------------


2. (U) At the 2nd Malaysian Islamic Finance Conference in Kuala
Lumpur last month, Central Bank Governor Dr. Zeti Akhtar Aziz
announced that Malaysia accounted for about two-thirds of
outstanding Islamic bonds throughout the world, amounting to roughly
US$47 billion in 2007. High savings rates in Asia and the Middle
East were driving demand, she said, resulting in an average growth
rate of 40% per year in the scale of the Islamic bond market.

How to Build the Industry
--------------


3. (U) While Governor Zeti focused largely on Malaysia's success
with Islamic bonds, other speakers at the conference focused on what
needed to be done to build the industry. Malaysia's RHB Islamic
Bank chairman Vaseehar Hassan urged Malaysian Islamic banks to
venture overseas and establish links with Middle Eastern markets,
while also calling for non-Malaysian banks to issue Islamic bonds in
Malaysia.


Still a Developing Capital Market
--------------


4. (U) Investors at the conference complained that the Islamic
derivative market was inadequate, and that there was almost no
secondary domestic market for Islamic products. There are simply

too few players and intermediaries, they commented, so most
investors prefer holding their investments. Moreover, few Islamic
derivative products exist. Some investors also accused banks of not
being transparent in risk management due to the lack of Islamic
derivatives for hedging purposes. Similarly, international rating
agencies have noted the difficulty in rating Islamic products as
there are few products for benchmarking. In the case of Islamic
REITs (Real Estate Investment Trust),Moody's Representative
Director Christina Maynes said it was very much a conventional REIT
in Malaysia's case. However, she commented that Middle Eastern
investors generally preferred to invest in real estate directly.


Double the Legal Fees
--------------


5. (U) Issuers complained about the difficulty and higher cost in
coming up with Sharia-compliant products. Legal fees essentially
double with the added layer of a board of Islamic scholars who must
adjudicate Sharia-compliance.

Sharia-compliance a high bar to meet
--------------


6. (SBU) In addition, Sharia compliance is stringent: in addition
to the basic prohibitions, like alcohol, gambling, etc., income from
interest and debt to asset ratios must be below certain thresholds.
Ed Teather, Executive Director and Senior Economist for ASEAN
Research, told ECONOFF that these kinds of requirements made Islamic
finance theoretically viable for refinancing existing assets, but
nearly impossible to finance a new initiative that exists only as a
blueprint or a business plan. In addition, he pointed out that with
the current excess liquidity in the market it simply did not make
economic sense for corporations to go to the added trouble and extra
expense of issuing Islamic products.


KUALA LUMP 00001462 002 OF 002


Shortage of experts
--------------


7. (U) Yet another barrier is a lack of skilled Islamic finance
professionals. Banking professionals are seldom proficient in
Sharia, while Islamic scholars are seldom proficient in finance.
The GOM is providing scholarships to Malays who want to study
Islamic finance and has established a training entity funded and
coordinated through the Central Bank. The 2008 budget proposes to
exempt expatriate Islamic finance professionals from paying income
tax in an effort to attract more talent from the Middle East.

Working Towards Becoming "Purely Islamic"
--------------


8. (U) Islamic finance, as it is currently practiced, is not
regarded as "pure" by many practitioners and scholars. However,
there is a general consensus among these experts on the need to
build the industry until it can become independent of the global
conventional finance system. Until then, interest rates remain the
fundamental benchmark for pricing and the mingling of Islamic and
conventional assets will continue.


9. (U) Islamic finance, which forbids charging interest, uses an
underlying asset to structure a "trade" as a substitute for a loan.
For example, a contract is written to buy a specific amount of wheat
and then re-sell the wheat at a specified later date at a different
price. The price difference can be used to finance an entirely
unrelated transaction. The concept of the time value of money is
ignored, and the difference between the purchase and resale price is
attributed solely to risk. A blind eye is turned to the fact that
compensation for "risk" is equal to what a conventional bank would
charge in interest, and this "risk" even can be compounded daily.
Practitioners acknowledge this and other "impurities" in how Islamic
finance is carried out, but hope that someday the industry will grow
big enough to establish its own benchmarks.


10. (SBU) The concerns of some practitioners go further. Rafe
Haneef, Citibank's Head of Islamic Finance for Asia, told ECONOFF
that in order to truly practice Islamic finance, one had to be
concerned about what the next customer did with the wheat even after
the Islamic bank no longer held title to it. The wheat could be
sold for consumption, but once it had been used in an Islamic
transaction, it should not be used in any interest-bearing
transaction. He said this would be "like selling grapes to a
winemaker."


11. (SBU) Because the market for Islamic finance remains small, some
mingling of funds is inevitable, as there simply are not enough
Islamic financial products available. "All roads lead to U.S.
Treasury bonds eventually," explained David "Daud Abdullah" Vichary,
a longtime Islamic finance practitioner and British national. As the
same money gets circulated, it is impossible to shelter it from
conventional finance, he told ECONOFF.

Comment
--------------


12. (U) Whether or not Islamic finance will overcome its obstacles
and become a major global industry remains an open question. The
vision of its promoters is to tolerate a bit of un-Islamic
"impurity" for now out of necessity, but to gradually move toward a
"purer" form as the industry grows. In Malaysia, with the
government in an activist mode, the approach to Islamic finance is
more pragmatic than pure, and it appears to be a growing reality.

KEITH