Strong Growth Predicted for Malaysian Islamic Finance: Focus on Takaful Market and Sukuk Issuance

Malaysia’s takaful sector should expand by 20% through to 2014 on consumer awareness and spending as well as regulatory reforms, according to brokerage firm OSK Research’s latest report on the sector.

The firm said that more people and companies will buy into takaful products, providing liquidity in sukuk and shariah-compliant instruments to support investment income even as the industry is able to increase capacity to cater to the demand, as well as strengthening takaful and retakaful capacity.

The increased capacity is partly due to the expected finalisation of the Malaysian government’s framework for risk-based capital (RBC) for Islamic banking and takaful. The industry expects the shariah-compliant framework to be essentially similar to the framework that is currently applied to conventional insurers but will add to the valuation of the takaful sector.

OSK Research said the new framework for Islamic banking and takaful, coupled with the requirements of the Malaysian Competition Act may trigger mergers and acquisitions among takaful players as they attempt to pool capital and size in order to compete in the market.

The risk-based capital (RBC) framework for Islamic banking and takaful, expected to be finalised soon, is not expected to significantly differ from the framework applied to conventional insurers, but will nonetheless enhance valuations in the Takaful sector, the report notes. It added the RBC framework could also spur merger and acquisition (M&A) activity in the sector given that smaller takaful and insurance players may lack the capital and size to compete in the market.

Fitch Also Expects More Sukuk Issues

In a separate report Fitch Ratings says strong demand will ensure that sukuk issuance will grow in 2013, mainly in originator-backed (also called asset-based) sukuk structures.

The credit ratings agency (CRA) notes that the sukuk market is growing rapidly. 2012 global sukuk issuances are expected to hit US$121bn according to Thomson Reuters, following a strong year in 2011 where issuance was USD$84.4bn, a 62% increase on 2010, according to Zawya Sukuk Monitor.

Confidence and investor sentiment toward Islamic bonds have contributed to growth although limitations remain, one of them being the legal precedents in terms of effective enforcement in many jurisdictions where sukuk issuance is prevalent. As such, it remains uncertain whether certificate holders will be able to enforce their contractual rights in local courts. Fitch also believes that sukuk do not have a standard structure and each structure may involve differing underlying contractual arrangements. As a result, each structure has to be reviewed individually to assess whether it fits within these criteria.

Currently a rating is only mandatory in Malaysia but not in the Gulf Cooperation Council (GCC), however there is no doubt that sukuk rating is an important element of improving the confidence in this growing instrument. Fitch believes that the majority of sukuk will continue to come from originator-backed (also called asset-based) in which investors rely upon direct support features (i.e., the repurchase agreement and liquidity arrangements), as well as upon the originator/issuer’s ability to generate profits with the assets.

Fitch also expects that there is an opportunity to see shariah-compliant debt in sovereigns that have yet to tap the sukuk market, such as Egypt, Libya, Oman and Tunisia, and this would be likely to generate strong investor appetite. The Turkish government entered the Islamic capital market in September 2012 with a US$1.5bn Eurobond issuance, considered a key driver to establish a benchmark and to encourage the development of the sukuk market in Turkey. Jordan passed a law paving the way for sovereign issues last September.

Additionally, France, South Korea and South Africa have stated their interest in tapping the sukuk market. Fitch still sees that issuers from outside the Islamic world could contribute more eventually to the increase in supply as they diversify their investor base. Sovereigns would be well placed to tap demand, as they are unlikely to have to struggle to find assets that qualify to back shariah-compliant bond issuance.

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