TOPIC ONE :

BUILDING THE SUCCESS CAPABILITIES TO GLOBALIZE

MALAYSIA’S TREASURY AND CAPITAL MARKET

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

“Building the Success Capabilities to Globalize

Malaysia’s Treasury and Capital Market”

by Calbert Loh Wai Mun, Bangkok Bank Berhad

 

Changing economic and business environment as well as rapid technological advances over the last decade has had significant impact on the development of the Malaysia’s financial system, domestically and globally. Global forces at work and advances in technology have redefined the rules of the game and transformed the operational environment within which financial institutions operate. Indeed, the ability to reap the benefits arising from greater competition depends largely on the capability and capacity of financial institutions to adapt swiftly and to embrace the changes.

 

Similarly, the rapid pace of economic development and transformation that creates new demands as well as opportunities for businesses have called for a more effective and efficient provision of financial services both in the treasury and capital market. In moving ahead, a well-defined strategy will need to be formulated for the financial sector if it were to prosper in the new environment and play a meaningful role in the nation’s future economic development.

Financial Flows and Investment

In order to spur further growth in the financial industry market, Malaysia needs to continue to promote foreign direct investment (FDIs). The financial industry companies need to undertake cross-border investments to grow their overseas markets, seize new investment opportunities, acquire new technology and expand the sources of financial instrument product and services.

 

The attraction of foreign investment and global financial flows through the creation of 'conducive conditions' in globalization of Malaysia’s treasury and capital market are presumed. Malaysia’s growth domestic product (GDP) has an average growth rate of 6% with a forecast average inflation rate of 5.8% this year and a further reduction to 3.5% in 2009. Malaysia’s share of inward foreign direct investment (FDI) into South, East and South-East Asia region rose to 3.4% in year 2007, the highest in five years from 2.9% in year 2006 as per Table 1 and 2. China and Hong Kong combined continued to take up the lion share of it, accounting for a total share of 57.9% in 2007, followed by Singapore 9.7% and India 9.3%. Consequently, according to the Malaysia Industrial Development Authority (MIDA) figures, Malaysia’s ranking in attracting FDI into the region jumped to the 6th place in year 2007 from 7th place previous year despite initial fears of the ongoing financial crisis in the United States will have a spillover effect to Malaysia. Malaysia approved a total of MYR36.8 billion worth of investment projects during January-August period of year 2008 far exceeding the MYR33.4 billion throughout last year.

 

 

Globalization Objectives To Be Met For The Financial Sector

The objective of the globalization of treasury and capital market is therefore to develop a more resilient, competitive and dynamic financial system with best practices, that supports and contributes positively to the growth of the economy. The development of domestic institutions that form the core of an efficient, effective and stable financial sector is an important part of this process based on the following factors:-

•     It is envisaged that Malaysia’s real economy will continue to expand significantly during the decade, becoming more internationally integrated and more dynamic. Globalization of the financial system is the next step to undertake amid strong growth in high-tech services, greater reliance on small and medium-sized industries (SMIs) with increasingly rapid rate of innovation, and with more differentiated and demanding consumers.

•     To serve this dynamic economy efficiently and effectively, and to ensure that domestic institutions will have a leading role within it, the financial sector, particularly its domestic institutions will need to be more focused, efficient and innovative.

 

 

 

•     The regulatory framework within which the financial industry operates will be based on a supervised market approach. The regulations will allow product innovations and market activism, while being strongly supervised by standards and prudential requirements.

•     A strong financial landscape will consist of a more diversified range of ‘brick and mortar’ financial service providers, from large one-stop financial centres to niche providers, of specialist services competing with ‘virtual’ providers across most product areas. In addition, the capital market will have a relatively more important role in the allocation of resources and risks.

 

Key Drivers To Globalization

As changes in the global financial industry continue to evolve and accelerate in the new millennium, the Malaysian financial system, particularly domestic banking institutions and insurance companies will face mounting pressure to become more efficient and competitive, innovative, technology-driven, and strategically more focused. The financial infrastructure will have to be developed accordingly to facilitate and support this development.

 

1.1  Greater Competition Driven by Deregulation, Consolidation, New Entrants and Greater Price Transparency

Globalization, deregulation, consolidation and emergence of virtual marketplaces are intensifying competition. In some Asian economies, foreign ownership limits have been raised significantly with most no longer having foreign ownership limits, deregulating price controls, issuing of new banking licenses or allowing universal banking.

 

 

1.2  Growing Capital Market Will Increasingly Result In Disintermediation

As the domestic capital market deepens, there will also be a shift from bank lending to the capital market. Large domestic corporate will also seek to list their shares on foreign stock exchanges, in order to have access to global equity market in order to tap the lowest cost and most stable funds.

 

 

 

1.3  Financial Institutions Are Using New Organisational Structures and More Aggressive Compensation Models, and Relying On Alliances and Third Party Relationships

In an ever-growing, fast changing business environment, the value of good ideas is correspondingly multiplied, and the value of top talent increases accordingly. The best talent, technology and strategy that come with it, are increasingly unaffordable and have to be accessed externally. As a result, the use of new compensation structure as well as outsourcing and alliances by financial institutions are becoming widespread.

 

Building The Success Capabilities

In order to bring in greater innovation, flexibility and dynamism into the Malaysian financial system, measures to identify the weakness and to remove impediments to progress will be implemented, beginning with improvements in infrastructure and increasing the intensity of domestic competition, so as to allow best institutions to flourish.

 

1.1  Develop An Industry-Wide Benchmarks To Drive Performance

An industry-wide benchmarking programme provides a powerful tool for greater strategic focusing, for guiding domestic banking institutions to measure their own performance in ways that will highlight both operational and strategic opportunities and for the implementation of skill building measures. A working group or committee needs to be set-up to analysis on the financial and operating statistics data, an effective risk management process and to conduct customer need analysis and satisfaction surveys.

 

 

1.2  Promoting Best Practices, Conduct Focused Training and Accreditation Of Credit Officers and Managers

The institutional bodies such as Institute of Bank-Bank Malaysia (IBBM), Rating Agency Malaysia (RAM) and other financial institutions need to improve awareness of best practices and conduct industry-wide focused training which includes periodic discussion groups. The main area of focus includes electronic commerce and banking, procurement of operational support system, performance management, consumer marketing and credit risk management. The implementation of accreditation of credit officers and managers by Bank Negara Malaysia (BNM) will raise awareness and improve minimum standards on credit risk management.

 

1.3  Remove Restrictions on Financial Institutions Staff Mobility, Movement and Salaries

Human capital is the most important asset for the financial banking industry in order to ensure sufficient pool of human talent. In order to attract the very best people in the domestic banking institutions from abroad and locally, higher staff salaries increment which is based on global standards need to be implemented while the penalty for domestic staff pinching will need to be gradually removed. As a medium term strategy, employment for new international talents from competent expatriates on a contractual basis with more flexible remuneration packages will serve as a mean for transferring of skills and technology. However, it is in the interest of the country over the long term to develop its own pool of domestic skills and talents. In addition, the setting-up of single website for staff recruitments among the financial institutions working hand-in-hand with the role of unions and associations to increase staff mobility and redeployment into other areas and later transformed into performance based incentives.

 

1.4  Setting-up Of One-stop Financial Centres

There has been a global trend for financial institution to create a one-stop financial centres that offer wide ranging facilities to their customers. The ability to offer customers a broad range of financial services such as treasury and capital market instruments through the same distribution channel will be the key to building stronger customer knowledge and better competitive advantage. This will include allowing financial institutions involved in cross-selling to consolidate their balance sheets and operate as a single entity holding multiple licenses, subject to prudential considerations.

 

 

 

 

1.5  Adopt “What Is Not Prohibited Is Allowed” Regulatory Philosophy

The present approach involves pre-approval requirement restriction on new treasury and capital market activities. Although some restrictions are necessary for prudential purposes or consumer protection, the requirement for approval to conduct activities that are not clearly forbidden has been viewed as an impediment to innovation. The adoption of “what is not prohibited is allowed” philosophy will act as a guide for financial institutions to innovative ventures rather than to remain with their traditional approaches. A simple product notification process to the regulatory bodies will be sufficient to ensure that regulators are aware of market development on new products. A set of clear guidelines for applications for regulatory exemptions will need to be issued by Bank Negara Malaysia (BNM) in order to reduce respond time and reasons for rejection of new products to indicate the nature of the regulatory concerns. In this case, the financial institutions will need to improve the level of product transparency and consumer education with a more efficient structure involving the Financial Mediation Bureau (FMB) to address consumer complaints.

 

1.6  Deregulate Pricing and Rules of Association on Fees, Charges and Mandate All Financial Institutions To Be Rated

A key element in driving performance improvement in the financial industry is to increase the competitive intensity with market-determined prices. Further liberalization of fees and charges to avoid high lending margins, overpricing to customers, implementation of price cap and to facilitate product bundling for segment-targeted pricing. Under a more liberalized and globalized environment, there is greater demand for transparency thus the rating requirement by at least a local rating agency will improve market discipline.

                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

1.7  Implement A System Of Incremental Enforcement Actions And Early Warning System

Incremental enforcement actions against problem financial institutions will need to be developed to implement examiners’ finding which is divided into informal and formal enforcement actions. Informal action include signing of Memorandum of Understanding (MoU) among the financial institutions while formal action ensure the financial institutions seek remedial actions on the findings raised by the examiners. In addition, prompt corrective actions will be taken in cases where specific early warning indicators are reached such as declining risk-weighted capital (RWCR) which indicates deterioration in the overall soundness of the financial institutions.

 

Conclusion

While measures have been taken to increase domestic capacity to globalize the Malaysia’s treasury and capital market, implementation of the recommendations is advisable to be implemented in a practical manner such that the desired outcomes are achieved without any destabilising impacts to the financial sector. However, in the globalize environment, tougher measures by incorporation of new Anti-Trust Regulations to address financial market monopolistic behaviors and to implement Consumer Protection Act to promote market-orientated consumer protection environment needs to be handled carefully by Bank Negara Malaysia (BNM) officials. Whilst it is motivated by the need to globalize the treasury and capital market, it would also be tampered with a sense of practicality and reality of the international financial market.

 

References

1        Jan Aart Scholte, “Globalization: A Critical Introduction”, 2000

2        Joseph E. Stiglitz, “Globalization and Its Discontents”, 2007

3        Robert Jackson and Georg Sorensen, “Introduction to International Relations: Theories and Approaches”, 2006

4        Thomas Friedman, “The World is Flat: The Globalized World in the Twenty-first Century”, 2003

5        Tim Dunne, Milja Kurki and Steve Smith, “International Relations Theories: Discipline and Diversity”, 2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BUILDING THE SUCCESSFUL CAPABILITIES TO GLOBALIZE MALAYSIA’S TREASURY AND CAPITAL MARKET

By Lim King Guan

OCBC Bank (Malaysia) Bhd

 

 

Despite the recent turmoil in the global financial market, a truly integrated globalized capital market is still the way moving forward. Only by a truly integrated globalized capital market where capital can be efficiently mobilized to maximize creation of economic value. Malaysia, with its open and diverse society and economy, progressive policy and world-class hard and soft capital, is in a very advantageous position on the globalized capital market bandwagon. For Malaysia to capture this opportunity, it must develop and excel the necessary capabilities for such globalized capital marketplace.

 

 

Backbones of a Successful Globalized Capital Market

 

The golden rule of a successful capital marketplace is the ability to match buyers and sellers. Based on this golden rule, the backbones of the successful globalized capital market can be best illustrated as follow:

 

 

 

 

 

 

 

 

 

Access:

 

§         Market players

 

To be a successful capital market, Malaysia needs participation of a large pool of global market players. Large market player pool will directly drive more market liquidity and depth. In this aspect, Malaysia has enormous advantage over the other nations because of its diverse culture and multilingual society. Malaysia can be the world’s financial bridge between the East and the West and the Islamic and the conventional. Malaysia is capable of bringing together large pool of market players from different regions of different needs and perspectives, fostering greater market liquidity and depth.

 

§         Capital

 

A truly global capital marketplace requires truly free flow of global capital. Investors and borrowers alike want absolute freedom to mobilize their funds, and they put high value for such freedom. Capital freedom will attract greater market players’ interests. Hence, Malaysia needs to progressively liberalize capital control towards capital freedom.

 

Also, to be a successful globalized capital market, Malaysia’s capital market must be multi-currency. Not only Malaysia needs to attract diverse market players, Malaysia’s capital market must be capable of facilitating transactions in various currencies, especially the G7 and regional currencies, giving the market players the flexibility to their liking.

 

§         Market Intermediaries

 

Market intermediaries, ie. banks, brokers and exchanges, play very crucial roles in networking the market players, facilitating transactions and creating liquidity. Malaysia needs to continue opening up its financial industry by promoting cross-border presence and welcoming global banks, brokers and exchanges. With their worldwide network, the global market intermediaries will help raising Malaysia’s name in the global marketplace and bringing in global capital flows to the Malaysia’s capital market. In addition, these global market intermediaries will also bring in new talents and technologies, bringing the Malaysia’s capital market to the forefront of the global capital markets.

 

 

Information Consistency and Transparency:

 

§         Market convention

 

For the global market players, consistent and standardized market conventions give high comfort in minimizing errors and confusion. In order for Malaysia to appeal the largest most possible pool of global players, Malaysia needs to have consistent and standardized market conventions that are in line with the global standards.

 

 

 

 

 

When setting market conventions, Malaysia needs to think globally and fix market conventions that are appealing to the largest pool of market players. In collaboration with foreign nations, Malaysia should encourage for standardized market conventions in areas where Malaysia has significant presence and influence, such as the Islamic and the regional capital markets. For new innovation, Malaysia can even take the lead in setting the global standards.

 

§         Information source

 

Access to information is crucial to give market players, especially the global market players who are distant apart from Malaysia, the comfort and confidence in order for the Malaysia’s capital market to turn global. Malaysia has so far achieved great strides in promoting market transparency, by making a lot of market information available to the market players through Bank Negara Malaysia and Bursa Malaysia. To further build on the well-laid foundation, Malaysia can expand even greater collaboration with the global financial information vendors, ie. Bloomberg and Reuters. Trading and information platforms can be integrated, making market information readily available to the widest pool of global market players.

 

 

Technology:

 

§         Dealing infrastructure

 

Access is the gateway of capital market, and it is often the key of a market success. For Malaysia to become a truly globalized capital market, it needs to provide market players the access at around the world via the most widely available trading platform. For this purpose, Malaysia can collaborate with and integrate its dealing infrastructure with the major global dealing platforms. By tying up with the major global platforms, this will also give larger pool of global players the access to the Malaysia’s capital market.

 

Also, to be successful as a globalized capital market, Malaysia’s dealing infrastructure must be at par with the world’s ever-advancing financial system. Malaysia’s infrastructure must be able to interface and close transactions seamlessly with the global systems. Collaboration with the major dealing platforms will help to meet such requirement.

 

§         Product types

 

As an emerging capital market, Malaysia still has a lot of room to grow in terms of product depth. Often, investors’ comfort with the existing product types has kept the market from making product advancement. Both originators and investors still require more education in order to widen the product depth.

 

In addition to product education, the Malaysia’s market also needs a pool advanced sophisticated market players to drive product innovation. These advanced market players, with their advanced product knowledge and experience, will help to kick start activity in new innovative products. Once liquidity is available and successful track record is proven, the rest of the market will eventually follow suit. The market will need innovative talents, from local as well as global, to play the role of innovation pioneers.

 

Government Policy:

 

§         Conducive policy

 

Conducive government policies are crucial for building the backbones for the Malaysia’s capital market to go global. Malaysia’s financial market policy, including market guidelines, foreign exchange policies and tax rules, needs to be promoting market access, ensuring information consistency and transparency, and encouraging technological improvement.

 

In addition to setting the capital market framework, the government should also be ready to implement initiatives that will help to kick-start certain key aspects of the capital market backbones. Especially for the top-level market rules and conventions and infrastructure issues, governments must work together in order to have a successful integration.

 

§         Market regulation

 

Systematic and orderly operation is critical for confidence in any capital market. Although market regulators in principle should leave the market to function autonomously, regulators must also strike the sensitive balance in exercising their regulatory power to ensure an orderly market.

 

Malaysia needs to have a comprehensive regulatory framework that is tailored for a globalized capital marketplace. The task is massive as the framework must be ready to deal with a large and diverse pool of market players, capital flows by global scale and ever-improving financial technologies. Also, such regulatory framework must be in-sync with the global capital market in order to be relevant, consistent and effective.

 

 

Conclusion:

 

Building a globalized Malaysia’s treasury and capital market is a complex task, but this is a necessary step for the Malaysia’s market to move forward and to stay on the global financial map. The backbones of such globalized capital market are inter-connected as development in one aspect will aid advancement in other aspects, or vice versa. The effort will require significant public and private involvements as well as international collaborations. The market’s mindset must also turn towards global.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

TOPIC TWO :

GLOBAL ISLAMIC FINANCE – THE CHALLENGES AND SOLUTIONS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GLOBAL ISLAMIC FINANCE : THE CHALLENGES AND SOLUTIONS

by Lois Lim Pooi Kuan

Alliance Bank Malaysia Bhd

 

 

1.0 Introduction

 

Islamic finance  is a type of banking system that follows the Shariah principles. It comes into existence when the Muslims believe that the Quran disallow certain practices that are central to Western finance, such as receiving the payment of interest (riba) and conducting financial speculation (gharar). Hence, Islamic finance was formed over the past years in order to provide them with basic banking and insurance products that are compatible with the Shariah principles.

 

There is a dramatic transformation of the Islamic industry since it was established where its participants involves not only the Muslim community but also the non-Muslim community. Islamic finance is now so widely practiced that its assets is estimated to have grown to around 20 per cent a year since 2000 and are currently worth about $500 billion globally.

 

Malaysia has launched its plan to become a centre for Islamic banking and finance for more than 30 years; and the country is encouraging foreign participants to enter the market. Recently, France has taken a significant step towards establishing Paris as a western centre for Islamic finance. Then, UK is now home to five licensed Islamic banks, the only licensed ones in the EU. This fast growing segment has even spurred Tokyo and Hong Kong to initiate plans to integrate Islamic finance into their financial system. Nonetheless, the drawing of interest to follow such principles comes a long way and it is still facing many challenges in its process to achieve global recognition.

 

 

2.0 Challenges & Solutions

 

2.1 Skills Shortages

 

One of the major challenges encountered by the Islamic financial industry is the shortages of specialists who have the relevant experience to work in such sophisticated field. As financial innovation increases, the range of Islamic financial products and services widens. This heightens the problem of recruiting employees that are familiar with such products as it becomes more comprehensive.

 

The pressure to look for qualifiers was intensified when the central bank of Malaysia has to meet its 2010 deadline to convert 20 per cent of the banking sector to Islamic finance. As the number of Islamic financial institutions increases, the demand for these pools of talents to be in the industry becomes crucial to ensure its competitiveness to operate in parallel with the conventional financial system.

 

As an Islamic financial hub, it is a good move by the Malaysian government to form the International Centre for Education in Islamic Finance (INCEIF) in 2006 to increase its human capital. Despite having students from over 40 countries taking part in INCEIF, continuous advertising should be carried out nationwide and worldwide to increase the younger generations’ awareness of this ever fast growing market. On the local front, seminars and talks should be held more often in universities for students who wish to pursue a post graduate degree programme in Islamic finance.

 

 

2.2 Lack of Standardisation

 

With Islamic finance spreading fast to establish international transaction, little was done in standardising the regulatory compliance in this industry. The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) was developed in 1990 that serves as a coordination of accounting standards across different jurisdictions. Notwithstanding the fact that AAOIFI provides common standards for scholars to adhere to, there is insufficient transparency on its regulatory framework for complex products such as derivatives. In addition, there are also no Islamic laws when it comes to specific areas like hire purchase, partnerships and company law. This could result in inconsistency as Shariah interpretation varies between regions. For example, in Britain, there are companies that appoint their own Shariah compliancy boards where they help to structure the Shariah compliance agreement for these companies. This could create discrepancy as to the different practices in other nations.

 

Unlike the different conventional accounting standards being applied in different parts of the world, Islamic finance stems from the same belief of Islamic principle and as such, standardisation and clarity is of utmost importance in its early stage of successful development across the globe. To overcome such uncertainty, standards relating to Islamic finance should be revised when deemed necessary according to the current changes in the market practice. Also, practitioners should be encouraged to raise any ambiguity to the Islamic Financial Services Board (IFSB) on issues which are not clearly specified in the standard. At the same time, they should also provide the Board with suggestions and best practices on how to undertake complicated financial transactions.

 

 

2.3 Association of Islamic Finance with Political Agenda

 

There is often a minority group of people who still view that political Islam is linked to Islamic finance. The global war against terrorism waged by the United States (US) has intensified the search for solutions within Islam. It ultimately creates an obstacle of accessing the American market as the sector surges forward into the west. US are a huge and potential market whereby Islamic finance provides an alternative choice of investment banking as it appeals not only to the Muslims but also the non-Muslims. The idea of having Islamic finance to have relation with political Islam should be diminished. In fact, the factors behind the sector’s development have more to do with economics than politics.

 

Therefore, critical measures need to be taken to better converse what Islamic finance is about to decision-makers abroad. Countries which have long history of adopting Islamic finance such as Malaysia should conduct campaigns and talks in the neighboring countries of the targeting nation. This is to deepen the understanding of Islamic finance knowledge and its idea behind it. Not only that the targeting nation could be induced by its neighboring country’s move to implement Islamic finance into their financial system, it also creates confidence in them to venture into this young and evolving industry.

 

 

2.4 Insufficient influence in shaping the banking sector

 

Being around for a few decades since it was established, Islamic finance is still incomparable against the conventional banking in terms of having the capacity in shaping the market. The banking industries around the world are still highly dependent on the conventional market. Financial institutions are trying to introduce Islamic banking products but are tailored to suit the conventional investors. As such, there is of no difference between Islamic finance and the conventional banking.

 

Practioners should be innovative to come up with products that holds Islamic finance Syariah principle and at the same time being able to satisfy the customers needs. Governments or the relevant authorities of different nations should take initiative to develop the sector by allowing more Islamic bank to be established within the region. The concept and idea of Islamic banking should be well communicated to customers who seek to invest in Islamic products.

 

 

3.0 Conclusion

 

Despite confronted with challenges ahead, the outlook for Islamic finance is bright and can foresee the sector playing a bigger role in the global finance over the next decade. Being conservative in their investments, Islamic finance has shield itself against global subprime crises. As it gains its popularity, Islamic finance has offered vast business opportunities made possible by the huge amount of Islamic funding available. Hence, sustaining the overall soundness of the Islamic financial system becomes essential towards contributing greater global financial stability in the international financial system.

 

 

 

 

 

Global Islamic Finance “The Challenges And Solutions”

by Calbert Loh Wai Mun, Bangkok Bank Berhad

 

Global Islamic finance has become a force to be reckoned with in the global economic environment. It often forms part of the equation in international financial system, whether at a government-to-government or the private sector levels. Development in global Islamic finance is now beginning to play a significant role in the Islamic financial systems beyond Muslim countries to Asia, Europe and the United States, as it offers a way to diversify investment portfolios and manage risks.

 

Robust Growth in Global Islamic Finance

 

According to the Institute of Islamic Banking and Insurance (IIBI) , there are more than 267 Islamic financial institutions (FIs) operating in 75 countries. Total Islamic assets under management by Islamic banks and conventional banks offering Islamic banking services exceeded US$ 500 billion in year 2007 which maintain their current annual growth rate of roughly 20% to US$ 1 trillion by year 2010. This includes banks, mutual funds, mortgage companies and takaful companies. Islamic mutual funds were estimated at about US$ 300 billion with an annual growth rate of 23.5% over the past 5 years , while global takaful or Shariah-compliant insurance contributions were about US$ 5 billion. There is an approximation of US$ 1.5 trillion of Gulf Co-operation Council region (GCC) funds held in investment assets worldwide i.e. US Treasuries, corporate bonds, equities and other investments. By year 2020, there will be 2.5 billion of Muslim population worldwide from the current 1.5 billion population level in year 2007-2008 which constitutes 24% of world population. Retail deposits of Islamic banks in the Middle East achieve high average annual growth rates of around 15%-20% per annum is expected to manage 40%-50% of total savings of Muslim population in 8 to 10 years period. Therefore, the Islamic financial services are estimated at US$ 4 trillion by year 2020. The potential is huge.

 

Robust growth in new sukuk issuance worldwide increased more than double from US$ 11.8 billion in year 2005 to US$ 20.6 billion in year 2006 reflecting growing demand around the globe. For the year 2007 saw an exceptional growth of global new sukuk market issuance, expanded by more than 70%, which reached a record high of US$ 47 billion. Total outstanding of global sukuk market worldwide is projected to exceed US$ 200 billion in year 2010 from US$ 50 billion as of year 2007. In this regards, Malaysia’s sukuk represented 68.4% of the total global sukuk outstanding worldwide valued at US$ 46.8 billion in year 2007.

 

Global Islamic Finance Challenges Ahead

 

In order to cater for the robust growth and fast evolution of the Islamic financial system, there is an immediate need to modernize with innovated Islamic financial infrastructure to facilitate greater integration between Islamic financial and capital market. Major challenges need to be confronted and resolved in order to facilitate progressive development in well established and emerging financial centres.

 

1.1    Lack of Develop and Standardise Global Islamic Capital Market Practices

Regulatory supervision needs to establish more robust discussion platform for International Islamic banking community to promote understanding of supervisory philosophy and objective within different jurisdictions. Divergence of Shariah views and opinions in Islamic financial transactions among scholars remain a challenge. Global Islamic capital market operates across multiple jurisdictions, with ineffective cross-border supervision objectives and philosophies. There is a lack of exchange of information and ideas on issues relating to capital market practices, Shariah opinion interpretation, changes in business models and capacity building efforts. Global uniformity of capital market practices and common understanding of specific risks to facilitate cross border transaction and global convention remains a barrier amid wide spectrum of supervisory philosophies ranging from well-structured development of markets and regulation to full market driven approach.

 

 

 

 

 

 

1.2    Lack of Global Systems, Multicurrency Islamic Financial Instruments and Shortage of Global Investment Bankers

Unlike conventional, Islamic financial market is lagging behind in global system, multicurrency innovations and instruments to cater for business expansion in an increasingly complex and challenging environment. There is a need for home-host regulatory supervision capability to select relevant information to be shared cross-border without compromising data sensitivity and confidentiality. Legal framework may not be ready and lack of Islamic understanding remains a challenge in order to create an effective and efficient regulatory framework. Immediate shortage of global investment bankers need to be addressed which must have the same knowledge, appreciation on capital market practices and common understanding of specific unique risks being emitted by the Islamic financial systems.

 

1.3    Lack of Liquid and Efficient Islamic Market

Regulatory supervisions need to be implemented to enhance Islamic instruments liquidity in order to build investor confidence and increase competition in the environment of integrity and fairness. Maximising information channels ensure information transparency in the primary and secondary market which provides an optimal and efficient level to boost investor demands for Islamic securities.

 

1.4    Lack of Good Corporate Governance Practices and Risk Management

The role of Shariah Supervisory Board (SSB) in governance needs to be clearly defined with detail processes and controls to protect Investment Account Holder (IAH). There is a lack of transparency and disclosure in financial reporting in respect to investment accounts which is required to promote market discipline. The absence of capability to capture Islamic risk transformation and unique risks pose great challenges for regulatory supervisions to ensure adequate capital charge for Islamic financial institutions.

 

Global Islamic Finance Solutions

 

In essence, to ensure Islamic financial industry is effective and efficient, greater coordination and cooperation needs to be adopted. In view of rapid evolution and dynamism of global Islamic financial system, regulatory gaps exist as supervisory for Islamic financial institutions is still at developing stage which requires immediate solutions.

 

 

 

 

 

 

2.1               Promoting The Adoption Of International Standard Regulation and Best Market Practices

In this aspect, significant progress has been made by the establishment of Islamic Financial Services Board (IFSB) in year 2002 which provides Islamic governance regulatory standards. So far, there are five standards being issued and/or in process of issuance which includes:-

·   Guiding Principles for Risk Management dated December 2005

·   Capital Adequacy Standard dated December 2005

·   Guiding Principles on Corporate governance dated December 2006

·   Disclosure to Promote Transparency and Market Discipline in progress (draft)

·   Guidance on Key Elements in The Supervisory Review Process in progress (draft)

 

The General Council for Islamic Banks and Financial Institutions (CIBAFI) was established to enhance market understanding of Islamic finance. In addition, in order to promote good corporate governance, the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) was founded in year 1990 while the Arbitration and Reconciliation Centre for Islamic Financial Industry (ARCIFI) was created for dispute resolution services for members in order to improve confidence in the international arbitration system. The IFSB and AAOIFI have played an important role in harmonizing prudential accounting standards in which Islamic financial institutions are also required to combat anti-money laundering (AML) and anti-terrorist financing.

 

2.2               Interconnected Islamic Global Central Clearing and Settlement Systems (CCSS)

Having a comprehensive supporting infrastructure is a prerequisite to a vibrant Islamic capital market development which operates in an ecosystem that interacts with each other. Market participants of this CCSS will include cash settlements banks, regulatory central banks, custodian or depository banks, central depository, information provides, stock exchanges that provide trading, listing, clearing and settlement mechanism. This interconnected CCSS operates in an automated systems environment to ensure speed, reliability and consistency, reduction of credit, liquidity, legal and operational risks in order to facilitate efficient capital and trade flows.

 

 

 

 

2.3               A Set of Laws, Guidelines and Agreements Is The Foundation For An Effective System

The legal and technical infrastructure needs to be set-up for transfer ownership rights i.e. title of securities and to enhance resilience, stability and operational consistency in the Islamic financial system. Global system shall be governed by a finality Act to ensure legal finality of settlements for systematic payment and settlement systems. The main objective is to reduce systematic risk in global clearing systems, ensure that the failure of a market participant in the system does not have spillover effects on other participants, thereby preserving system stability. In this regards, rules of designated payment systems take precedence over normal insolvency law. The Memorandum of Understanding (MoU) between governing authorities to clarify roles and responsibilities on Islamic infrastructure in strengthening the global system helps reduce systematic risk and to ensure overall financial stability. Other agreements, market ethics and code of conduct to facilitate the smooth running of the global system and to protect market participants include:-

·   Depository Paying Agency Agreement

·   Islamic Securities Borrowing and Lending Master Agreement

·   ISDA/ IIFM Islamic Derivatives Master Agreement

·   Global Market Code of Conduct for Principals and Brokers

·   The Model Code issued by ACI The Financial Market Association[14] with local addendum adopted in May 2002

 

2.4  Establishment of Fair Global Risk Sharing, Risk Disclosure and Reciprocal Funding Arrangement

The establishment of a fair global risk sharing arrangement ensures the Islamic financial institution will share the profit or loss incurred by the entrepreneur invested from the Investment Account Holder (IAH). Global risk disclosure arrangement needs to be established to disclose any explicit risk based on the investor and entrepreneur relationship. IAH bears fully investment risk and determine the investments or assets profile while the Islamic financial institution is exposed to negligence risk with greater fiduciary duty to protect IAH’s investment.

 

The global reciprocal funding arrangement leverage on the relative strength of each Islamic financial institution’s in their respective domestic currencies to raise funds for their subsidiaries or related companies with real investment activity by issuance of bank guarantee or stand-by line of credit (SBLC). This arrangement works well in for cross border presence of Islamic financial conglomerates such as Kuwait Finance House, Al-Rajhi Banking Investment Corporation, Lariba American Finance House and other institutions. Below is an example illustration of Islamic reciprocal netting cum guarantee/SBLC agreement.

 

 

2.5 Strengthening Information Sharing and Human Talent Development To Promote Innovation

Extensive information and trading channels for Islamic financial industry needs to be set-up which includes online trading service and information channels. Protection cross-border accessibility and mobility with disclosure of resulting regulatory cost is used to encourage retail participation.

 

Investment in human talent development is important to ensure sufficient pool of the talent and expertise. The drive for innovation has expanded to investment and equity linked products based on mainly Islamic equity financing and debt financing concept. The establishment of the International Centre for Education in Islamic Finance (INCEIF) in March 2006, the Islamic Research and Training Institute (IRTI) and the International Shariah Research Academy (ISRA) in year 2008 were to promote Islamic educational excellence, research work conforming to Shariah and to encourage active engagement and dialogue among global Shariah scholars into convergence of views from different jurisdictions.

 

 

2.6        Increased Foreign Entry and Participation In Islamic Financial System

The Islamic financial system needs to diversify in terms of market participants to ensure continuous robust growth which comprises of Islamic banking institutions, the takaful companies, the non-banking institutions, Islamic investment and capital markets. Progressive liberalization to allow for increased foreign entry and participation can facilitate greater cross border flows and strengthen the international financial inter-linkages. The issuance of new Islamic bank licenses, increased foreign ownership in both Islamic banks and takaful companies, establishment of foreign fund managers and foreign stockbrokers shall provide a new phase of development for the global Islamic finance.

 

Conclusion


The global Islamic financial sector is seen as one of the most progressive and attractive given the numerous incentives planned and further liberation in the coming years. Increased innovations in Islamic financial products call for greater emphasis in assessing higher quality of risk management and implementation of prudential governance practices by the Islamic Financial Services Board (IFSB) . Going forward, given the Shariah principles prohibit excessive leverage and speculative financial activities thus insulating the parties involved from excessive risks exposures, global Islamic finance will continue to be viable in contributing towards global financial stability.                                    

 


References

  1. Aggarwal, R.K. and T. Yousef, “Islamic Banks and Investment Financing”, Journal of Money, Credit and Banking, Vol 32, 93-120 (2000)
  2. Ahmad, A. “Economic Development in Islamic Perspective Revisited”, Review of Islamic Economics, No. 9, 83-102 (2000)
  3. Alexander, C. “The Present and Future of Financial Risk Management”, Journal of Financial Econometrics, Vol. 3. No. 1 3-25 (2005)
  4. Baker, M.J. Stein, and J. Wurgler, “When Does the Market Matter? Stock Prices and the Investment of Equity Dependent firms”, Quarterly Journal of Economics 118, 969-1005 (2203)
  5. Khan, M. and A. Mirakhor, “Islamic Banking: Experiences in the Islamic Republic or Iran and Pakistan”, Economic Development and Cultural change, Vol 38, 353-375 (1990)
  6. Khan, Mohsin S. “Islamic Interest-Free Banking: A Theoretical Analysis”, IMF Staff Papers: 1-27 (1986)
  7. Siddiqi, M. Nejatullah, “An Overview of Public Borrowing in Early Islamic History”, Islamic Economic Studies 2(2) 61-78 (1995)

 

 

 

 

 

 

GLOBAL ISLAMIC FINANCE : THE CHALLENGES AND SOLUTIONS

by Lee Keng Fah

Hong Leong Bank Bhd

 

                                                                                               

INTRODUCTION

 

From the world’s fist Islamic bank founded in 1975, the global demand for Islamic finance started to surge last five years. Sniffing opportunities, global conventional banks now are scrambling to set up Shariah-compliant operations from full-service investment banks to specialist advisory firms. Products also have moved beyond lending, insurance and investment funds to include sukuk, hedge funds, currency swaps and more.

 

Despite this bloom, the Islamic finance has yet to reach global critical scale. Institute for Middle Eastern and Islamic studies at Durham University UK estimates Islamic banking assets is just less than 0.50% of the world’s total  while worldwide sukuk debt outstanding is abut USD 100 billion which  about 0.1% of the global bond market.

 

For Islamic finance is to further integrate into global financial system, the industry is certain required to make progress in addressing to the challenges ahead.

 

1. CHALLENGES AND SOLUTIONS

 

Broadly, these can be categorized into three groups i.e. theoretical, operational and implementation1. These are discussed as follows:

 

1.1.            Theoretical Challenges

This relates to the further work needed on core principles of Islamic economics, and understanding of the functionality of a financial system operating on a profit and loss sharing basis.

 

1.1.1.                  Islamic Economics

Currently, market participants are still not very clear how Islamic economics is different from the traditional economics. There is virtually little organized support in terms of incentives, recognitions and scholarships to refine Islamic economics as compared to the multitude private and public foundations providing financial assistance to research in traditional economics.

 

1.1.2.                  Risk Sharing Financial System

There is still lack of understanding on Profit and Loss system which is consistent with Islamic concept of “profit is for those who bear risk”. Profits are distributed per ration stipulated in the contracts, and any losses are also distributed equally depending on the respective party’s stake holding.

So to narrow the gap between Islamic and conventional financial systems, it is critical to execute following action points:

(i)                  To establish foundations to support Islamic scholars in terms of incentives, recognitions and scholarships for research achievements.

(ii)                To derive experience from the history of traditional economics development (both its success and failures) in Islamic economics research.

(iii)               To develop a consensus based language and terminologies in Islamic economics.

 

1.2.            Operational Challenges

This relates to the innovations, intermediation and risk management issues.

1.2.1.         Innovation

As the perception of profit sharing mechanism in Islamic finance in general are high risks, this leads to a concentration of assets portfolio in Islamic banks in short term and trade related assets. This is exacerbated by the lack of deep and efficient capital and money markets to hedge the relevant portfolios.

 

So it is imperative to focus on the development of Shariah compliant instruments that meet the risk reward profiles of both investors and issuers. For further advancement of Islamic finance, it is crucial to develop an index as a benchmark representing the returns on profit / loss sharing basis rather than the current proxy interest rate (“LIBOR”) based benchmark

 

 

1.2.2.         Intermediation

While there is an impressive growth in Islamic finance, in reality these Islamic banks merely act as intermediaries between financial resources of Muslim and conventional commercial banks. In other words, this is only one way relationship.

 

For further growth in global Islamic finance, there is urgent need to be able to develop Shariah compliant asset portfolios generated in Muslim countries to be marketed in the West as well as marketing Western countries Shariah compliant portfolio to Muslim communities. 

 

1.2.3.                 Risk Management

(a) Credit Risk

Albeit the ethical framework governing Islamic finance prohibits gambling, speculation and interest, it does not mean that an Islamic bank runs little to no risk at all. Like conventional banks, Islamic banks do incur liquidity, credit, settlement, leverage, operational and business risks. In fact, Islamic banks also incur risks that are not common in conventional banks, these are as follows:

 

i)                    Fiduciary Risk – it relates to the nature of the Murabaha contract, which places liability for losses on the Mudarib (“agent”) in the case of malfeasance, negligence or breach of contract on the part of the management of Murabaha.

ii)                   Displaced Commercial Risk – it relates to the common practice among Islamic banks to smooth the financial returns to the investment account holders by varying the percentage of profit taken as the Mudarib share, which can be compared to an arrangement or agency fee.

 

(b) Capital Adequacy and Minimum Capital Requirements

Under Basel II accord, banks (both conventional and Islamic) are required to hold a minimum level of capital to prevent over-lending and to ensure that every bank has the sufficient funds in case any of its counterparties default without endangering of depositors, the banking system or the economy. Generally, large banks with sophisdicated risk management system will benefit from the new regulations and see their capital reduced as a result of applying the more advanced approaches. However, Islamic banks may not be able to justify investments on the same scale and will therefore not in a positions to benefit from the advanced risk management approaches

 

(c) Balance Sheet Size and Loss data History

The absence of significant amount of loss data is one of the main issues that hinder smaller sized Islamic banks to comply with Basel II requirement of seven years of loss data. To date, there is yet to have a database for Islamic banks.

 

 

(d) Capital Intensive Islamic Transactions

The Basel Committee on Banking Supervision (“BCBS”) has taken the stance that banks should not hold significant equity positions in companies they finance. Since Murabaha and Musharaka transactions are based on profit sharing principles, these are deemed to be similar as holding equity from regulatory perspective. Thus, these transactions attract rather significant risk capital charge of 400%.

 

Given the exponential growth of global Islamic finance, balance sheet size and lack of loss data are not expected to remain issues for Islamic banks in the long run. So ensuring the use of robust internal counterparty rating system would have a positive impact on the risk management process, thus the level of capital required.

 

To reduce the capital charge of Murabaha and Musharaka transactions, Islamic banks should act together to present a case to Basel II‘s committee on the basis of lower chances of default.

 

 

 

 

 

The development of a loss experience database, such as Pan European Credit Data Consortium (“PECDC”) or the North American Loan Loss Database (“NALLD”) could potentially resolve the issue concerning the length of loss data.

 

Selection of trustworthy third party to manage and create a comprehensive loss database for global Islamic finance would ensure Islamic banks to start designing advanced risk management models.

 

 

1.3.            Implementation Challenges

It relates to the efforts required on a system-wide implementation. At present, many Islamic banks suffer from financial disequilibria that frustrate attempts to adopt Islamic finance platform. These imbalances come from fiscal, monetary and external sector of respective economies. The main reasons are as follows:

 

(i)                  Lack of legal and institutional frameworks that facilitate appropriate contracts as well as mechanism to enforce them

(ii)                Lack of Shariah compliant instrument range and maturity tenure.

 

So, an immediate attentetion is requited to unified efforts to form an international regulatory regime to:

 

(i)                  develop risk sharing financial instruments and benchmark

(ii)                develop liquid secondary and money market instruments

(iii)               develop instrument for effective monetary and fiscal policy controls

(iv)              formalize accounting and auditing standards

(v)                train more Shariah scholars to vet Islamic financial products for Shariah compliance.

 

CONCLUSION

 

It is no doubt that Islamic finance has become part of global financial system and it does offer tremendous potential for development and growth. As witnessed, much work has been done by all fronts for the development of global Islamic finance however much more tasks remain to be fulfilled. It cannot be denied that

 

For global Islamic finance to experience “quantum leap” growth rates and remarkable breakthroughs as well as further integration in international financial markets, the world undoubtedly needs a Leader to champion for this noble cause especially under prevailing uncertain and dynamic environment. Otherwise global Islamic finance is no different from any products submitting to the conventional product life cycle, so nothing much to shout about.

 

 

                                                                                                           

References:

1. Zamir Iqbal & Abbas Mirakhor. An Introduction to Islamic Finance- Theory and Finance(2007). pg 296-311

 

2. AAOIFI (2002), Accounting, Auditing and Governance Standards for Islamic Financial Institutions. Accounting and Auditing Organisation for Islamic Institutions, Baharin.

 

2. S.Archer and R.A.A. Karim “ On capital Structure Risk Sharing and Capital Adequacy in Islamic Banks” International Journal of Theoretical and Applied Finance9, No3 (2006). pg 269-280.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Islamic Finance: Overcoming Global Challenges

By Raiyan Abdul  Rahim

OCBC Bank (Malaysia) Bhd

 

Islamic finance has developed phenomenally in the past two decades. Currently, in a time where giant economies and western markets are headed towards disaster, Islamic finance has steadily continued to thrive. The Islamic finance market has assets totaling more than USD 700 billion and is expected to reach USD 1 trillion by 2010, if not sooner.

 

Islamic finance was actually introduced more than 1400 years ago, when the Prophet Muhammad (peace be upon him) was alive. However, during his time Islamic finance transactions mainly involved trading of goods and services between individuals. Nowadays, Islamic finance products have expanded to include housing loans, takaful (Islamic insurance), corporate bonds, treasury products, and even hedge funds.

 

The principles of Islamic finance are defined by Islamic law, also known as Syariah. Syariah forbids riba, which is translated as interest or usury. Syariah also forbids gharar, which is associated with uncertainty and speculation. Islamic commercial transactions must also steer clear of prohibited industries, for example, alcohol, gambling and pornography. Syariah also discourages heavy borrowing and the trading of debt.

 

Despite its many prohibitions, it appears that Syariah compliance has made Islamic finance transactions immune to the financial crisis being faced elsewhere. For example, when the London and New York stock markets crashed, the Islamic arm of the Dow Jones was hardly scratched.

 

This immunity has been largely explained by the fact that Islamic financial transactions must be supported by real assets. Because of this, it is void of subprime mortgages which have been bogusly repackaged to earn high credit ratings. Furthermore, Islamic finance encourages profit-sharing between banks and their counterparts. This places responsibility on the banks to ensure the deals go through and the risks are mitigated.

 

However, this immunity is not expected to prevail for much longer. It is inevitable that the Islamic markets will also be affected by the global credit crisis, especially because most of its investments are in private equity or the property market.

 

To overcome this, the Islamic market will need to diversify their investment channels. Instead of a heavy reliance on property, Islamic markets could instead turn to food and agricultural commodities, such as rice, wheat or soybeans. Alternatively, they could consider investing in logistics of developing countries such as China or Brazil.

 

There should also be an attitude change on the equity side. Islamic players should not only invest in private equity, but should also consider public equity. Almost a decade ago, the Dow Jones Islamic Market Index and the Financial Times Stock Exchange Global Islamic Index Series were launched. However, despite a vast number of companies being listed, they have hardly been tapped into by Islamic players.

 

 

Expertise in Islamic Finance

 

Although core elements of Islamic finance are established by the Holy Quran and the Prophet Muhammad’s teachings, many products today apply new financial concepts. Because of this, Syariah scholars also need to make new decisions on the legitimacy of these products. However, Syariah scholars who are often experts in Islamic law are not necessarily experts in finance.

 

Islamic banks and conventional banks with Islamic windows usually have a Syariah committee who are paid to oversee the Syariah compliance of the banks’ products. But not all of them have experienced working in a bank or financial institution. Instead, their expertise is usually developed based on theory and is academically oriented.

 

New Islamic markets are emerging and existing ones are constantly evolving, for example, the capital market, foreign exchange market and derivatives market. The level of Islamic finance expertise must increase in tandem with the evolution of these Islamic markets.

 

To enable this to happen, Syariah advisors should be required to attend practical courses and regular in-house training so that they can be exposed to the true workings of the institutions and the industry’s various developments. They cannot be disconnected from the industry which they are employed to guide.

 

Additionally, figures who demonstrate expertise in conventional banking and finance, Muslim or non-Muslim, should also be encouraged to study Syariah law and understand Islamic finance principles in depth. By combining their industry experience and Islamic knowledge, they will be able to develop new and dynamic Islamic products. They will also be able to contribute to policy making and legal reform.

 

Governments should also encourage universities and educational institutions to offer practical courses and professional qualifications in Islamic finance. It should not just be Islamic institutions which offer such programs. It is also important for the world’s leading universities to become involved because they can produce quality graduates to influence the direction of Islamic finance.

 

Furthermore, learning Islamic finance should not just be about knowing Islamic history or memorizing the Holy Quran. It should focus on sophistication in financial thinking, innovation and the ability to challenge one’s creativity.

 

 

Creating the Demand

 

Although Islamic markets have been growing, Islamic finance only makes up less than 1 per cent of the world’s capital. In order for it to expand its horizons, it will need to create more demand for Syariah compliant products. Increased demand will encourage banks and financial institutions to develop more products and encourage governments to develop policies to accommodate them.

 

There are more than 1 billion Muslims in the world. But not all of them will be depositors, investors or require housing loans. Because of this, to really grow, Islamic players must make their products attractive to non-Muslims as well. This will depend on their marketing strategies.

 

Attracting Muslims to use Islamic products is easy; simply tug at their religious heartstrings. Attracting non-Muslims will require more work. Islamic banks and other financial institutions will need to offer competitive pricing which is at par or better than their conventional counterparts.

 

But before that, Islamic markets will need to ensure they detach themselves from the idea that Islamic finance is strictly for Arabs or suitable only for Muslims. Instead, they should focus on elements which non-Muslims could relate to as well, for example, profit-sharing and asset-backed securities. Some non-Muslims are becoming attracted to the Islamic market because it does not invest in industries such as pornography and armaments, thus making it more ethical.

 

 

Legal and Regulatory Standards

 

Few countries have a completely Islamic financial system. Most countries will have Islamic banks and financial institutions operating within a conventional system. Because of this, they are subject to the countries national laws even though their products are Syariah compliant.

 

In the United Kingdom, for example, the situation is complicated because Islamic transactions are enforced according to common law. It was made quite clear in the case of Shamil Bank of Bahrain EC v Beximco Pharmaceuticals Ltd that the courts would not determine cases based on Syariah law.

 

Because it is unlikely that Islamic products will obtain recognition from the courts, Islamic players must lobby for their respective governments to make this recognition through legislation. In Malaysia, for example,  the Islamic Banking Act 1983 and the Takaful Act 1984, both make reference to Syariah, hence allowing Islamic commercial transactions to have some standing within the country’s legal system.

 

Other laws, for example relating to taxation, also need to be reformed in some countries. Islamic products will often involve transfer of ownership and other underlying transactions which make them different to their conventional counterparts. However, they should not face any drawback because of these differences.

 

The United Kingdom recently amended their tax laws to ensure Islamic products which are based on rent and profits, instead of interest, are not disadvantaged. In the Australian state of Victoria, amendments were also made to its legislation to accommodate for Murabahah based products. They are no longer subject to double stamp duty, despite having both a sale and a purchase of an asset.

 

As for regulatory requirements, different countries will have different standards. It may sometimes be difficult for Islamic banks and financial institutions to meet these standards, particularly if they were created to only cater for a conventional system.

 

In risk management, for example, the tools used by conventional banks often involve derivatives, which are prohibited by Syariah scholars. As for liquidity management, it can also be challenging because most of the instruments available, such as interbank deposits and government securities, often impose interest and therefore cannot be utilized by Islamic banks.

 

 

Some Islamic banks have been very creative and have developed products similar to inter-bank deposits based on the concept of commodity murabahah. Other banks are also constantly trying to develop new tools. However, this will take time. Islamic markets are not very large in volume and are still very illiquid in many countries. In the meantime, Islamic players should work closely with regulatory bodies so they can understand the constraints being faced and work towards making the regulations more flexible.

 

Conclusion

 

As a new and growing sector in the global market, Islamic finance will undoubtedly face many challenges. Its performance so far has demonstrated that it can overcome these challenges, be it in creating demand for its products, expanding its knowledge base, or even influencing reform in legal systems.

 

But to overcome these challenges effectively, there needs to be a joint venture between Muslims and non-Muslims. There needs to be cooperation between the finance industry and government authorities. Legal institutions and academic bodies should also become involved. 

 

At a time when the global market is facing uncertainty and instability, Islamic finance, the sector which shows the most promise, is worth venturing into. But there will have to be real commitment if we want the promise to become something more. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

TOPIC THREE :

ENHANCING THE SECONDARY TRADING OF TREASURY

AND CAPITAL MARKET INSTRUMENTS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

“Enhancing the secondary trading of Treasury and

Capital Market Instruments”

by Calbert Loh Wai Mun, Bangkok Bank Berhad

Treasury instruments refer to foreign exchange (FX), derivatives, Money Market deposits (MMD) and Fixed Income instruments where as capital market instruments is characterized by large variety of financial instruments to raise long-term funds i.e. equity, preference shares and corporate bond market i.e. conventional or Islamic private debt securities. The secondary trading market is the financial market for trading of securities that have already been issued in the primary market offering. The market that exists in a new security just after the new issue is often referred to as the aftermarket. In this regards, discussion is focus on corporate bond secondary market i.e. once the newly issued bond market is traded in the secondary market, the secondary trading will commenced as market makers provide bids and offers in the new instruments.

Secondary Market Function

Secondary markets exist to correct imbalances between the supply of capital and the demand for capital among geographic regions, among different types of financial institutions, and among classes of assets or financial products. In the secondary market, securities are sold by and transferred from one investor or speculator to another. It is therefore important that the secondary market be highly liquid. Originally, the only way to create this liquidity was for investors and speculators to meet at a fixed place regularly; this is how capital market originated. As capital market evolved, secondary market are dealt between brokers and dealers and lately, involved electronic trading platform (ETP).

 

Similarly, secondary markets help to balance the supply of and demand for capital among different financial intermediaries or institutions. For example, employees provident funds (EPF) invest huge amounts of capital on a daily basis. While they have substantial capital to invest, they are not equipped to originate bonds or other financial instruments. Retail lending would simply be too expensive and too tedious for EPF to undertake. Conversely, commercial banks, investment bankers, and other institutions have particular expertise in originating bonds efficiently at the retail level. However, specific institutions may not have sufficient capital from depositors to meet demands. By selling bonds and other financial instruments in the secondary market, retail institutions can thus access much larger amounts of capital from EPF and other similar, wholesale financial institutions. The market mechanism enables different types of institutions to come together synergistically to finance home mortgages or other financial instruments.

 

 

Finally, secondary markets help to balance supply and demand among different classes of credit products. Institutions may sell bonds or other instruments in order to balance their portfolios, to match assets and liabilities, or to reduce credit concentrations. The availability of a secondary market thus enables institutions to more carefully manage the allocation of assets within their portfolios. Incidentally, secondary markets may also improve the quality of bond underwriting. Credit decisions become “transparent” when they are subject to review by potential secondary market investors. Over time, credit decisions and bond documentation may improve as a result of the trading of financial instruments in secondary markets. While secondary markets do not exist solely for the purpose of improving credit quality, the securitization process may produce better credits, or lower interest rates, as by-products.

 

Challenges In Secondary Market Trading

 

Challenges in the secondary market trading are often due to imbalances created from the lack of fundamental framework which impede the capital market formation.

 

1.1 The Primary Market Drives The Secondary Market

In this regards, the market sentiment in the successful higher bid-to-offer primary trading market drives the secondary trading market. A strong “value chain” beginning with the borrower and ending with the investor, form a set of suitable prices must prevail in order for the secondary market transaction to progress and completed. In the capital market, initial transaction costs are often negotiated between the originator of the bond and the borrower. If these initial prices are not sufficient to allow the originator to recoup costs and make a target rate of return once the bond is sold, the originator is unlikely to sell the bond.  Similar requisite conditions for bond coupon interest payment servicing, pooling, credit enhancement, securitization, and other components in the secondary market forms part of the “value chain."[22]

 

In addition, the pricing of each capital market component in the “value chain” is critical to the smooth functioning of a secondary market. Without proper prices and liquidity, the whole process is hampered. Often, corporate bond investors in the capital market do not want to recognize the market value of their bonds if that market value is determined to be less than the face value of the bond. The fact that prices set between issuer and bond investors are below market levels, thus ripples through to the bond sale transaction and often prevents further selling of subsequent corporate bond issuance. Thus, the decisions made in the primary market, i.e. the structure of the bond, the issuance size, its interest rate and term, directly affect the suitability of that bond for trading in a secondary market. In an emerging market, whether it is the Islamic bond market or the conventional market, the demand for debt capital in the primary market, coupled with the way the debt is structured, can have profound implications for the functioning of the secondary market.

 

1.2 Lack of Standardization and Expertise Slows Use of Secondary Markets

While the mortgage lending market is characterized by a high degree of uniformity among lending documents and underwriting standards, the secondary capital markets are not sufficiently large to dictate the bond structures or practices. Lack of standardization in the capital market, lack of uniformity of documents, wide variation of credit standards with different bond structures raises transaction costs and increases the price that must be charged at various stages of the secondary market “value chain”.

 

Solutions To Enhance Secondary Market Trading

 

2.1 Strong Regulatory Capital Market Framework and Sufficient Expertise

 

To the extent that documentation and underwriting can be standardized among classes of debt instruments rating, secondary market trading of the capital market will require strong regulatory framework. As important as standardization may be to the improvement of the secondary markets, even more importantly is the expertise of the financial institutions who originate the bond issuance. A robust regulatory capital market framework provides more conducive secondary trading market environment such as efficient trading and settlement system which is trader user-friendly.

 

2.2 Document Standardization

As noted earlier, many issuers simply do not get enough “hands-on” experience in writing a wide variety of bond issuance. Document standardization is important, but unless the lead manager understand which documents are appropriate for various types of loans, the quality of the bond submitted for sale in the secondary market may still suffer. One way to compensate for the lack of bond issuance experience may be to accredit lead managers and/or financial institutions by an independent educational excellence. The launching in a series of training seminars that culminates in certification in lead manager role under a unique arrangement with a renowned consultancy firm or higher education institution will be an added value. This is just one small step in the process of secondary market improvement.

 

 

 

Other steps that should be pursued include the application of new information and communications technologies such as high standard credit scoring models, distributed underwriting and other approved methodologies that may result in higher quality of bond issuances.

 

2.3 Strong and Active Market Players

Strategic solutions need to be adopted in order to develop a vibrant secondary trading of capital market. Strong and active capital market players in providing the breadth and depth with improved efficiency. Large pool of highly skilled and competent bond trader expertise, presence of professionals with desired skill set ensures sufficient competent pool of talent in the capital market. Diversification and sophistication of instruments development are needed to meet various investors and market requirements. A strong and wider pool of principal dealership (PD) mechanism provides an efficient trading infrastructure in developing market maker and enhanced liquidity in the secondary market. Principal dealers that provide constant liquidity in the financial market needs to be provided with added incentives such as lower statutory reserve requirement (SRR), lower risk premium, easy access in securities for short selling activities and higher tax deductions on expenses incurred. Continuous upgrade and efficiency improvement in price discovery attracts larger scope of foreign investor participation into the primary and secondary markets.

 

Conclusion

 

There are a variety of issues that constrain the growth of secondary trading of treasury and capital markets. Some of these issues are related directly to illiquid capital market while others are inherent from the fundamentals in the economy of the country. In assessing its strengths and weaknesses, a useful economic model needs to be developed to study the “value chain.” This model can help explain the factors that may lead to success or failure with respect to each component of a fully functioning secondary market. The grass-roots perspective to the challenges is nonetheless salient, because in the past capital market development, it is possible to create a secondary market for some of the most difficult assets with securitization, small-business medium-term notes programme and other, non-standard community development bonds. What is necessary now is to get about the business of completing the value chain, more incentives to encourage foreign investor participation such as stamp duty waiver and promotion for new institutions that can respond to the capital market transformation, and doing so without relying on dwindling regulatory resources. This is a tough challenge, it that can be met.

 

 

 

 

                      

References

  1. Andrew Fight, “Syndicated Lending (Essential Capital Markets)”.
  2. Botkin, James W., and Jana B. Matthews, “Winning Combinations: The Coming Wave of Entrepreneurial Partnerships between Large and Small Companies”, John Wiley & Sons, Inc. New York, 1992.
  3. Botkin and Matthews, “Value Chain Concept” focuses mainly upon entrepreneurial partnerships, on the chain of transactions inherent in a secondary market.
  4. Frank J. Fabozzi, “Bank Loans: Secondary Market and Portfolio Management”.

Vandell, Kerry E., “Improving Secondary Market in Rural Amer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

TOPIC FOUR :

FINANCIAL INNOVATIONS : WHAT IT TAKES TO BE

THE REGIONAL BEST

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Innovations: What It Takes To Be The Regional Best  

By Alfred Siew Heng Kit

Cagamas Berhad

 

 

Graduating in early 1995, I had the youthful, foolish aspiration of amassing as much material wealth as quickly as I could. Seduced not by the actions but by the high flying lifestyle of a certain 27 year trader called Nick Leeson, I thought I could fulfil my dreams of being a futures dealer right here in KL.

 

Malaysia was in the midst of launching its own derivatives exchanges then; the KL Options and Financial Futures Exchange (“KLOFFE”) and the Malaysian Monetary Exchange (“MME”). I promptly signed up for the Malaysian Futures and Options Registered Representative (“MFORR”) course, passed my papers before crossing my fingers to seek out a financial institution prepared to employ me. 

 

As luck had it, I was recruited by a financial institution which was willing to give me a chance. I thought I was well on my way to carve out a lucrative niche for myself.  That was probably a logical assumption then as I thought Malaysia was in a sweet spot of a regional financial sector boom. The sweet scent of the phenomenal equity bull run of 1993-94 was still strong, encouragement from the government was fantastic and with the mass recruitment of derivatives specialists from all over, one would have thought that Malaysia could at least have a decent claim as one the regional centres for derivatives.

 

The Present

 

            Fast forward to 2008. I didn’t happen to make my fortune in derivatives (or make any fortune for that matter). Nevertheless, derivatives now enjoys all the global primetime headlines for all the subprime reasons.

  

            It would probably be a fair assumption to mention that Malaysia doesn’t cross the minds of many as a regional centre for derivatives or even as a mainstream financial centre.

 

Nevertheless, I am thankful to the policies of the government in managing to carve out a niche in the areas of Islamic finance and debt capital markets  in which not only have I stood as a beneficiary but also in which Malaysia can lay claim as being among the best in the region.

 

Malaysia’s Niche

 

            Mention Islamic finance to a financial practitioner and Malaysia likely comes to mind.

 

 

 

Using the analogy of sports, Malaysia’s stature in this area is not restricted to merely being amongst the best in the Asian Games. Rather, Malaysia’s current rightful place in this particular event is for her to stand on the podium of the OLYMPICS stage.

 

            On the scale of the depth and innovativeness of the domestic currency debt market event, Malaysia would probably win the gold medal in the SEA Games. On the grander stage of the Asian Games,  we would probably be able to punch above our weight for a very strong showing.

 

Just how did we get this far in these blue ribbon events?

 

What It Took

 

            In the case of Islamic finance, the government had the foresight to recognize a niche that this was an area that we could excel and innovate in. The appropriate policies and goals were set in place a long way back before Islamic Finance was considered to be even “cool” or to be the “in thing”. A step by step approach was  conceptualized and executed.

 

Carrots were laid out to firstly local or locally incorporated institutions to ensure success domestically. Islamic financial institutions and Islamic windows were created. Following this, we then granted full Islamic banking licenses to institutions controlled by foreigners. Subsequent to that, we encouraged the participation of institutions to operate under the International Islamic Bank (“IIB”) framework..This, in my opinion, was probably the right step. The creation of a successful domestic model was crucial to firstly, build the confidence internally and secondly, as a role model to the world that this is something that is workable before moving to the next step. I shall personally term this model the “jaguh kampung” model.  

 

In this particular regard, it may not be such a bad thing to be a “jaguh kampong”. We have proven to the global audience that it is quite possible to have a vibrant Islamic financial system coexisting with an established and mainstream conventional system. This model of success is also replicated in the area of the insurance industry. The takaful sector is growing healthily alongside its conventional counterparts. Try calling this uninnovative. 

 

We may not have been the first to roll out an Islamic bank or a takaful company for that matter. But then again, neither did Henry Ford invent the automobile.  Nevertheless, our similarities are that we have a model, platform and infrastructure which not just works but works pretty darn well. To me, innovation does not necessarily mean the invention of the product alone but rather can also come from the process involved in the creation of the product.

 

 

 

 

They say imitation is the best compliment. Our model of Islamic finance is being replicated by several countries. A further testament of this success is in the form of Malaysian Islamic finance specialists who have been lured to the other developed or developing Islamic financial centres. We have a competent and innovative set of professionals who have not only populated the domestic scene but are now taking their expertise abroad.  Little wonder that we’re termed an export driven economy.  

 

The Asian financial crisis necessitated the creation of a deep, sophisticated market for private debt securities (“PDS”). This was to ensure that the systemic risks of a model which relies heavily on bank lending were mitigated. The crisis a decade ago presented an opportunity for the creation of a sound and innovative infrastructure for a ringgit PDS market. Though probably in the pipeline then, the success of the mentioned infrastructure was likely expedited due to a confluence of the government’s promotion,  accommodative policies and legislation; the pure necessity of a deep and liquid PDS market arising out of pressing events and the proactive role played by the market players themselves.

 

There was even a brief period between the end of 2007-2008 where there was even a clamour of  foreign corporate issuers making a beeline to KL to issue ringgit denominated PDS.  This adds further credence to Malaysia’s stature . While conditions in Europe and in the US did not render an economically viable corporate bonds issue, they turned their sights to Malaysia.

 

This shouldn’t be a surprise as we had the following factors to attract them:

 

1)     A regulatory environment which welcomed foreign issuers.

 

2)     A mature and innovative domestic bond market with a tried and tested infrastructure ( legal framework, proven trading infrastructure etc).

 

3)     A deep and liquid domestic PDS market with the ability to absorb a desired primary issue and to actively follow through with secondary market activities (To some extent, this may have been helped by a curious lot of domestic investors whose interest may have been piqued by the top notch ratings accorded to these prospective issuers by our local rating agencies).   

 

4)     A relatively stable currency of choice to denominate their issue in.

 

5)     An established rating system with competent experience with perhaps the comfort of a foreign tie up to lend further credence to its abilities.

 

 

 

 

The fact of the matter is that, yes….. they may have come to Malaysia because conditions in London and New York were tough. But then again, they did choose a ringgit PDS issue over an issue denominated in yuan, won, baht, or even a Singapore dollar. This might be a cynical view though. There were already issuers exploring Malaysia as an alternative choice platform for a diversified funding source even before the credit crisis unfolded.     

 

There is also the relatively little known fact that our national mortgage corporation ie. Cagamas Berhad is also model of success which we can all be proud of. Far from being unfairly associated with the likes of Fannie Mae or Freddie Mac (as some may have in mind), it has in fact been acknowledged by an organization none other than the World Bank as being one of the best models of a secondary mortgage liquidity facility provider globally. Again, in sporting terms, I would probably liken Cagamas to squash. It’s a sport where Malaysia is really good at but may not have a truly global recognition that it deserves as it is not an Olympic event yet. I feel Cagamas’ 22 years of operating history that has seen it ride out 2 recessions (including the Asian financial crisis) and together with it being at the forefront of the growth of the Malaysian capital markets industry certainly is another feather in the cap for the Malaysian financial sector.  Again, Cagamas is probably another tale of an innovative homegrown financial model which has done so well at home that its operating model may serve as a template of sorts for the other markets. 

 

The Threats

 

            Malaysia is effectively sandwiched between 2 major financial sectors in the same time zone; Singapore and Hong Kong. While we may have carved out certain niches that we can be proud of todate, Singapore and Hong Kong have the existing infrastructure and perhaps more importantly the potential  mindset to dethrone us in some of our prized niche ie. Islamic Finance.

 

            In my humble opinion, whatever that’s being said about the pie being big enough for all or that the market being big enough for more players does not quite address the point that should we simply lose out on a sukuk listing in Labuan because a potential issuer chose Singapore over us, then the cake simply can’t be big enough for all. It’s somewhat akin to a zero sum game for us if we simply rested on our laurels or if we continued to dwell on our past glories.

 

            We probably also need to plan the future courses of action carefully and embark on new initiatives on the right footing at the very start. I think when we had first begun our journey into Islamic finance, the dominant modality applied was the Al Bai Bithaman Ajil (“ABBA”) modality. Perhaps taking a cue from the iconic Swedish foursome; Abba then, it was probably a case of peer collective commercial pressure singing to the tune of “Money, Money, Money….”. This was perhaps an isolated case then of a “jaguh kampung” needing some international exposure and guidance that this was not quite the correct path. It is a well known fact that this modality is to say the least, not too popular in the Middle East and is also now having some domestic issues of its own. Thankfully, this is being rightfully addressed.

 

            Hong Kong, in its quest to host an Islamic finance hub of its own, has recently announced that the Hong Kong Airport Authority is planning an upto US$1 billion sukuk issue. Singapore is to my knowledge, considering legislation which promotes Islamic financing based on the modalities of ijarah and musharakah. I will probably imagine that the thought process involved in all these  will have been quite thorough if the targeted market is from the Middle East. All that is required now is an appropriate legal framework to support these initiatives.

 

Conclusion

 

            I think Malaysia has found a right niche in areas which I truly believe it can excel in. It may have been a blessing as well that the derivatives market did not take off or evolved the way it was planned as these are the very instruments now which are wrecking the global financial scene.

 

            However, we cannnot depend on “blessings in disguise” or being inward looking to move forward. There is probably a constant need to evolve or have the natural inertia to move us out of our comfort zone in order to maintain or further strengthen our particular niches. Otherwise we may just fade away.

 

            We used to be the global kings of badminton. Let’s just ask ourselves…..when was the last time we won the Thomas Cup? Where are the current badminton champions coming from and were they not upstarts previously?

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

“Financial innovations: what it takes to be the regional best”

by Calbert Loh Wai Mun, Bangkok Bank Berhad

The financial-services innovation ability contributes towards the company capability to meet short- and long-term performance targets. In order to succeed as the regional best, it is applicable to study the survey findings of the latest McKinsey Quarterly report of global executives , which suggest that innovation will be a major competitive battleground in the financial-services industry. Public and private service firms in retail banking, asset management, investment banking, insurance, and other financial services, consider product innovation as a priority and view business model innovation as growing in importance.

The financial-service industry has significant room to improve performance on a number of common best practices for fostering innovation, such as using consumer insights to drive new ideas and dedicating organizational structures and funds for innovation. More than half of the financial-service company has pockets of successful innovation, but the efforts are not developed and sustained throughout the company.

The Importance of Innovation

Continuous innovation is needed amid advancing technology, changing environment, evolving customer desires with competitors improving their products, processes and services. Lack of financial innovation will results in customers decline in buying the company old financial products and services which needs to be replaced. Sales, revenues, shareholder returns and stock price of the financial-services company will continue decline. Products are increasingly difficult to differentiate with customers being more sophisticated,  demanding and expect more in terms of customization, newness, quality and better pricing. With markets and technology changing fast, good ideas are quickly copied and there is continual pressure to devise new and better products, processes and services faster.

Innovation is also important to a company’s long-term success. According to McKinsey global survey, 57 percent of financial-services company view innovation as extremely or very important to the ability to meet revenue targets over the past one to three years as per Table 1 . Despite the problems faced by financial-services company in innovation practices, only 15 percent viewed financial innovation as less effective than those of their peers and competitors while 28 percent viewed financial-services company as being equally competitive.

Investing in Innovations

The financial-services company needs to develop a budget in spending money on innovation-related initiatives for meeting long-term as well as short-term performance targets. Innovation spending is typically among the first areas which the financial-services company will target whenever they cut costs to ensure the company’s over the next three years continuous growth with product innovation development and business model innovation as per Table 2.

 
 
 
The Financial-Services Innovation Challenge

Developing innovations in financial-services institutions remain a challenge as the two most important reasons are the cause and effect of short-term pressure i.e. expectations of short-term financial success coupled with resource allocation that slights innovation efforts in favor of short-term execution. Interestingly, the third most important factor is a lack of organizational mechanisms that would encourage the generation of new ideas and human talent development. Organizational shortcomings are a recurring theme, which other challenges include lack of insight understanding into the customer needs and behavior, compliance restriction, regulation pressure and senior management generally do not value innovation or generation of new ideas as per Table 3.

In the production and development environment, there is a conflict between innovation and the Six Sigma business management strategy. The Six Sigma attempts to reduce rework from the start, cutting down on costs and development cycle time which is used in business processes. Compared to the try-fail method, innovation practitioners may generate thousands of ideas before finding a really useful concept for developing a new product or service. Therefore, in order to gain greater benefits at a lower cost, a better plan for innovation integration is needed.

 

 

Sources of Ideas

The sources of innovation ideas primarily develop and initiated by the financial-service employees, as compared with less than 1 percent coming from senior management, the CEO, or the founder of the firm. These reflect a bottom-up approach to innovation at many companies, rather than active professional development and the management of an innovation strategy. The second most frequent source of ideas is the analysis of competitive and market dynamics contributing about at 61 percent; with 38 percent contribution from the use of data about consumer insights, behavior, and trends. External sources, such as partnerships and joint ventures, contributed about 33 percent as per Table 4. Other sources of ideas include one-on-one interview with customer, quantitative surveys, analysis of technological trends and data about customer insights, behavior and trends are valuable information. The relatively subdued roles of consumer insights and external sources suggest a fairly basic and conservative approach to innovation in large parts of the financial-services industry.

 
 
 
Solution : Organizing for Innovation Initiatives

The financial-service companies which have inadequate formal innovation structures with lack of organizational mechanism in place, needs to identify the barriers they face to commercialize innovations. Formal process to line up the necessary internal resources ensure innovation is carry-out in an orderly and organized process i.e. information technology (IT) readiness and to prioritize projects for these support functions as per Table 5.

An innovation council or committee that reviews innovative initiatives need to be set-up. Funds dedicated to innovation activities and a centralized research department or innovation centre ensures continuous success in innovation. In order to drive innovation, a dedicated team needs to be set-up to analyze problems, problem-solving and generate new ideas. Human talent development is important in search of new insights and understanding customer requirements in adopting the crowdsourcing method for product development efforts in order to ensure continuous flow of new ideas for innovation initiatives. Formal partnership with other research centre or academics and the establishment of corporate venture capital fund are an added advantage.

 

 

 

 

The Performance Gap

Most executives in the financial-service industry view substantial opportunity for their company to improve performance in practices that most industries regard as vital for successful innovation. Around 70 percent rate the financial-service company performance as poor or merely adequate in the following categories i.e. establishing clear incentives to innovate, setting clear targets and metrics for innovation initiatives, prototyping ideas for rapid commercialization, systematically providing funds for innovation projects, and developing a network of external partners to develop new ideas as per Table 6. Therefore, the performance gap report needs to be reviewed and monitored closely to track innovation development initiatives.

Conclusion

Financial innovative is a positive message and win customer enthusiastic support. Poor implementation of many recent corporate initiatives such as enterprise resource planning (ERP) implementation, international organization for standardization (ISO) 9000 implementation, reengineering and downsizing does not result in fast growth. Often this led to a reduction in quality levels and stagnation in sales. The ability to provide continuous innovation leads to faster growth, increased in market share and better corporate positioning.

Senior leadership’s active involvement and management in short- and long-term innovation initiatives would promote successful innovation. In addition, financial innovative development needs to be incorporated as a strategic corporate strategy. Moving forward, amid fast changing technology, shorter financial product lifetime and higher customer requirements, financial innovation ensures continuous success to be the regional best.

 

References

1.                   Daniel H. Pink “A Whole New Mind: Why Right-Brainers will rule”

2.                   G.S. Altshuller, "Theory of Inventive Problem Solving."

3.                   Jeffrey Phillips “Make us more Innovative”.

4.                   Keith Herndon, “Enterpreneurs and Innovations – Creating value with emerging technologies”.

5.                   Paul Slogan, “The Innovative Leader”.

6.                   Richard Florida, “The Rise of the Creative Class”.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Essay Title: Financial Innovations: What it takes to be regional best

By Tan Voon Ching

OSK Investment Bank Bhd

 

 

Innovation can be defined as “a new way of doing something”. It may refer to incremental, radical, and revolutionary changes in thinking, products, processes, or organization. Financial markets are always innovating, such innovations can affect the revolution the financial sector as a whole, relate to changes in business structures, to the establishment of new types of financial intermediaries, or to the legal and supervisory framework. It is an important source of economic growth in promoting the efficient allocation of capital and raising our standard of living, however, if it turns awry, it can be a cause of macroeconomic instability.

 

Financial innovation is the act of creating new financial instruments to increase the varieties of financial products to cater to the different needs of the market participants. It is closely related to financial engineering, which plays a vital role in the design, development, and the implementation of innovative financial instrument to form creative solutions to problems in the financial arena. Over the past decades, numerous financial products in the likes of Collateralized Debt Obligations (CDOs), Credit Default Swaps (CDSs) have been developed.

 

Broadly, financial innovation can be divided into 2 categories, namely product innovations and process innovations. Product innovation involves creation of new financial products whereas process innovation entails developing new financial services by the adoption of the latest technology. One of the main objectives of financial innovation is to improve the effectiveness of risk management. It is undeniable that financial innovation has been essential and persistent in the development of the economic landscape over the past few centuries. Hence, besides having the necessary infrastructure and technology, what are the elements required to help propel Malaysia to be the best in the Asian region in financial innovation?

 

Financial Innovation – The financial crisis (creative destruction)

The word ‘subprime’ has become a buzz word in the global financial market in recent times. The credit debacle started in the late 90s but has become more apparent throughout 2007 and 2008 after the bursting of the United States housing bubble and high default rates on “subprime” and adjustable rate mortgages (ARM) from 2005 to 2006. This crisis had led to the downfall of the global financial institutions. On September 15, 2008, the Lehman Brothers Holdings filed for Chapter 11 bankruptcy protection and this was the largest bankruptcy filing in US history with Lehman holding over US$600 billion worth of assets. On top of that, US Government had offered US$700 billion bailout plan to buy over ‘troubled assets’ in its bid to rescue the US financial system.

 

 

 

 

Following the crisis, some analysts had begun to question the rationale of structuring such complex financial instruments, which could potentially destroy the entire financial system. In his work entitled “Capitalism, Socialism and Democracy” (1942), Joseph Schumpeter introduced the concept of ‘creative destruction’ - a new system or concept designed to replace the old system. The current circumstances would present a good avenue for Malaysia to bring new breath to the dampening global financial industry.

 

One of the roots of the credit crisis is the complexities of the structured products. This is evident when even the Federal Reserve Chairman Ben Bernanke had to enroll into a 2-week course in order to fully understand these ‘creative’ financial products. For that reason, financial engineers could consider structuring financial instruments which are easily understood and accepted by retail investors whilst taking into account of the different investment appetites of investors from different regions. For instance, surveys have shown that many Asian investors are inclined to allocate huge portions of their incomes for saving purposes. Malaysia could focus on this niche market by specializing in structuring savings-related financial products to the Asian market. Recently, one of the local financial instutions had introduced a new saving structured product - Max InvestSave PSSIA-I, which is one good example of structured products that can be introduced to the market.

 

Secondly, the local unit trust companies could also implement the ‘glocal’ (a combination of global and local) concept in managing their investment portfolios. These companies could tap on local talents from around the world to manage the portfolio. For instance, one of the local banks has planned to launch an ASEAN equity-linked fund, hence they should hire the local talents from each ASEAN country to manage the portfolio as the local players are likely to have a better understanding of the local market.

 

One of the issues which surfaced following the subprime crisis is the absence of an independent committee or agency to evaluate or verify the credit ratings assigned to corporations by rating agencies. Many “troubled-assets” and securities backed by subprime mortgages were rated AAA initially. This has raised questions about the credibility of ratings assigned by rating agencies. For this reason, Malaysia could be the first in the global financial market to setup an independent watchdog or to have the existing Security Commission to evaluate the credibility of the ratings assigned by credit-rating agencies such as RAM and MARC. This would increase the transparency, reliability and effectiveness of the evaluation process of securities.

 

Islamic Financial Hub

With the globalization of Islamic finance and rapidly changing international Islamic financial landscape, Islamic finance is becoming increasingly integrated with the international financial system. In year 2007, the global sukuk market expanded by more than 70% and the new issuances during that year also reached a record high of US$47 billion. Adding to that, the total outstanding amount of global sukuk market has surpassed the US$100billion mark. Out of the total amount of outstanding global sukuk last year, two-thirds were accounted by Malaysia, signifying Malaysia as one of the significant global players in the Islamic finance market. Nonetheless, our neighbouring countries such as Singapore and Hong Kong are beginning to recognize the importance of Islamic finance in the global financial market. In recent years, these countries have started to build up the Islamic facilities in their financial market in order to ride on the current Islamic market boom. With the present financial crisis engulfing the western economy, it is worth noting that most countries which adopted Islamic finance have escaped relatively unscathed due to the greater transparency and the needs for real economic initiatives to support the transactions.

 

Consequently, this stiff competition in the global Islamic market might lead to the situation of red oceans. To avoid this situation, Malaysia can act differently through the financial innovations to maintain its leading status in the global Islamic market.  Despite the various Islamic concepts introduced, the Islamic financial products available in the market are limited to few underlying concepts such as bai bithaman ajil, istisna’, murabahah, mudharabah, musyarakah and ijarah. Hence, financial engineers should attempt to explore and apply other different Islamic concepts to structure more innovative financial instruments to cater to the needs of different users. We have yet to see concepts such as Bai Istijrar (contract of supply), Muzara’ah (Agriculture Joint Venture), Bai Arbun (sale with rights to exercise or cancel upon payment of earnest money) and Juaalah (contract of performing a task) used as the underlying contracts on for a financial market transactions.

 

In addition, the regulators could consider providing more incentives to those corporations in order to encourage financing through Islamic debt securities. Besides that, the regulators could also liberalize the financial processes such as issuance of new securities and simultaneously encourage offshore investors to invest in the Islamic financial products by providing them with different attractive incentives. For instance, they could do this by abolishing capital gain tax to lower transaction costs. This would increase the liquidity which is currently lacking in the local Islamic financial market.

 

New ways of transactions

Notably, retail investors in Malaysia have limited investment avenues aside from the stock market. For example, retail investors who have preference for bonds over equities could only invest in bonds via the Exchange Traded Funds or purchase other bond-related funds from unit trust companies. The standard trading amount for any direct bond investment is RM5 million, which could mean a hefty sum to most ordinary investors. In addition, based on a statistical analysis conducted by the writer, results indicated that the Dow Jones Index is positively correlated with the US treasuries’ yields whereas the KLCI Index is negatively correlated with the yields of Malaysian Government Securities (MGS). Consequently, retail investors find it difficult to seek shelter from safe-haven assets during gloomy economic environment. To counter this, the regulators could do their part by encouraging commercial banks to act as agents for the retail investors in bond transactions. Furthermore, the regulators could also introduce dual-mode transactions for the financial products which can only be traded over-the-counter (OTC) currently. In the United Kingdom, the interest-rates swap is not only traded OTC, investors can also do so through the exchange market. With this dual-mode transaction, it would likely improve the liquidity of the financial products as more options are available for investors to invest in the different financial products. And finally, the settlement system can be further enhanced by the adoption of the latest technology to ensure faster and secure payment.

 

 

In a nutshell, the current financial crisis could be a blessing in disguise as it provides an opportunity for Malaysia to be the leader in the Asian region in the area of financial innovation. Whilst adopting the latest technology to enhance the existing finance facilities, it is important that the regulators and financial engineers work hand-in-hand in introducing new approaches in the financial systems that can differentiate our country from our other Asian counterparts. The ongoing financial malaise has resulted in many investors losing faith in financial innovations. Hence, the regulators have a role to play in restoring investors’ confidence.  This can be made possible by educating investors about the ‘new baby’ of financial innovation and to ensure that investors are aware of the risk and reward of such products. We believe financial innovations play a vital role in bringing the financial industry to a higher level that can benefit the global citizens, providing the industry players refrain from using financial innovation for their own benefits.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

TOPIC FIVE :

DEVELOPMENT OF CREDIT DERIVATIVES MARKET AND

THE CHALLENGES IN MALAYSIA

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

“Development of Credit Derivatives Market and the Challenges in Malaysia”

by Calbert Loh Wai Mun, Bangkok Bank Berhad

The development of credit derivatives in Malaysia is a logical extension of the ever-growing array of derivatives trading in the market. The concept of a derivative is to create a contract that transfers some risk or some volatility. This risk or volatility may relate to the price or performance of a reference asset, event, a market price or any other economic or natural phenomenon. However, the derivative trade closely mimics risk and return of holding the underlying asset, or at least a segment thereof. Thus, derivatives bring about a completely independent trade in the risks or returns of an asset. For example, a trade in options or futures in equities may run completely independent of trades in equity shares.

 

Credit derivatives are in fact off-balance sheet derivative contracts that seek to transfer defined credit risks in a credit product or bunch of credit products to the counterparty to the derivative contract. The counterparty to the derivative contract could either be a market participant, or could be the capital market through the process of securitisation. The credit product might either be exposure inherent in a credit asset such as a loan, or might be generic credit risk such as bankruptcy risk of an entity. As the risks, and rewards commensurate with the risks, are transferred to the counterparty, the counterparty assumes the position of a virtual or synthetic holder of the credit asset. The counterparty buys the risk obviously for a premium, and the premium represents the rewards of the counterparty. One of the credit derivatives is credit default swap (CDS) which is essentially an option to swap a credit asset for cash to transfer credit risk, should it default. Table 1 below illustrates the buyers and sellers of credit default swaps (CDS) consists of mainly the hedge funds about 28%-31% and banks and dealers for the trading portfolios about 33%-39%.

 

 

The Development Of Credit Derivatives Market

1.1   Securitization

Given the fact that the synthetic market does not have several of the limitations or constraints of the market for cash bonds or loans, credit derivatives have become an alternative parallel trading instrument that is linked to the value of a corporation similar to equities and bonds. Coupled with the device of securitisation, credit derivatives have been rendered into investment products. Thus, investors may invest in credit linked notes and gain credit exposure to an entity, or a bunch of entities. Securitisation linked with credit derivatives has led to the commoditization of credit risk.

 

1.2   Index-link Products and Structured Credit Trading

Apart from commoditization of credit risk by securitisation, there are two other developments that seem to have contributed to the exponential growth of credit derivatives i.e. index products and structured credit trading. In the equities and bonds market, investors may acquire exposure to either a single entity’s stocks or bonds, or to a broad-based index. The logical outcome of the increasing popularity of credit derivatives was credit derivatives indices. Thus, instead of gaining or selling exposure to the credit risk of a single entity, one may buy or sell exposure to a broad-based index, or sub-indices, implying risk in a generalized, diversified index of names.

 

1.3   Tranching Or Structured Credit Trading

The idea of tranching or structured credit trading is essentially similar to that of seniority in the bond market i.e. one may have senior bonds, pari passu bonds, or junior bonds. In the credit derivatives market, this idea has been carried to a much more intensive level with tranches representing risk of different levels. These principles have been borrowed from the structured finance market. Thus, on a bunch of 100 names, one may take either the first 3% risk, or the 4% to 6% slice of the risk, or the 7% to 10% slice, and so on. The combination of tranching with the indices leads to trades in tranches of indices, opening doors for a wide range of strategies or views to take on credit risk.

 

1.4   Development Of Hedge Fund Industry

Quite often, the development of the global hedge fund industry has been associated with the development of credit derivatives. The global hedge funds are prominent in credit derivatives trades, particularly in case of the lower tranches of the structured credit spectrum represents the segment of investor capital that is least regulated, risk neutral, out to seize opportunities arising out of mispricing, etc. As the credit derivatives trades are almost completely unregulated and offer opportunities of short trades in credit not permitted by the bond market, the credit derivatives industry provides an excellent playing ground to the hedge funds.

 

Challenge of Credit Derivatives

1.1   Credit Risk

Credit risk is the risk inherent in credit, and credit is the very basis of our present society. Corporate defaults are reaching never-before dimensions, and have assumed far reaching impact. Market participants transacting in credit derivatives market instruments needs to have the capacity to understand and assess the credit-related risks inherent in these instruments. This knowledge includes the capacity to understand the major variables on which the valuation of the instrument depends and how the valuation of the instrument will be affected by changes in these variables. Corporate customer that undertake credit derivatives on both the asset and the liability side of the balance sheet needs to have the ability to assess on a comparable basis the relevant credit risk regardless of how the transaction appears on the balance sheet.

 

1.2   Lack Of Understanding and Liquidity In The Credit Derivatives Market

The opacity of the credit derivatives market, and especially of structured synthetic instruments, is a potential source of concern. The complex interaction between cash instruments and credit derivatives has made it increasingly difficult to monitor where different, possibly sizeable, positions are taken and where risks are concentrated. It is similarly difficult to monitor whether and when simultaneous attempts by market participants to unwind their positions could have an impact on market prices and systemic liquidity. It is therefore becoming increasingly important for risk managers, in both the private and the public sectors to understand which risks are being accumulated by what financial entities.

 

1.3   Lack Of Adequate Transparency Credit Derivatives Framework

More and improved data on net credit risk exposures and on the concentration of positions which tend to build up easily in highly leveraged and opaque markets which could help to mitigate sizeable shortcomings in both counterparty and systemic liquidity risk management. In fact, such data could help market participants and competent authorities to value, price and manage more effectively the increasing risks posed when investors behave in a homogenous way. It is important that adequate transparency framework be adopted but there is lack of broad consensus on how such a framework would be best implemented in order to provide timely and relevant information. Therefore, joint initiatives from regulatory and market players need to be set-up to improve transparency, especially to reduce pricing risks for illiquid products, enhance risk management capabilities, and support market discipline regarding counterparty risks, especially non-regulated entities are required.

 

 

 

 

Solutions To Meet Challenges

Given that the credit derivatives market has a global, innovative, complex and predominantly wholesale nature, it may be argued that global market standards are particularly well suited to meet related regulatory challenges.

 

2.1   Increased Transparency For Proper Evaluation Of Systematic Risk

Reference is made to both the reports i.e. Counterparty Risk Management Policy Group and the recent report released by the Institute of International Finance Special Committee on liquidity risk which calls for “greater transparency and an incremental collaborative mechanism between the public and private sector in contingency planning”. They also draw attention to the fact that standard methods for valuing contracts with defaulting counterparties under the close-out netting provisions of master agreements for derivatives transactions could be difficult to implement during periods of market stress. As noted by the Basel Committee on Payment and Settlement Systems, the efforts of the Committee on the Global Financial System (CGFS) to develop mechanisms that better identify aggregate information on credit risk will be strongly supported by supervisory authorities and market participants. Market players need to seek aggregation of credit risk to ensure that their measures of credit exposures to individual obligors are as comprehensive as possible i.e. including both direct exposures i.e. loans and over-the counter (OTC) derivatives exposures as well as indirect exposures from credit derivative transactions.

 

2.2   Common Market Standards And Legal Framework

The International Swaps and Derivatives Association (ISDA) are widely recognised as playing a crucial role in promoting market standards and mitigating legal risk. In this regard, there can be no doubt that the development of ISDA’s library of standard-form contracts for credit derivatives has played a substantial role in promoting the development of this market. It is important that market participants clearly understand the precise rights and obligations which they assume when entering into credit derivatives transactions, as standardised contracts do not always work out in the way that contracting parties anticipate. Also, in some instances, case law has demonstrated that the courts can take divergent views regarding the meaning of ISDA’s definitions of credit derivatives. These matters have been swiftly addressed by ISDA. The introduction of the International Financial Reporting Standards (IFRS) , if implemented consistently and reliably, should lead to a substantial increase in comparability and transparency. This should enhance the level playing-field between banking institutions and strengthen market discipline for the use of risk transfer instruments.

 

2.3   Dynamic Management of Structured Transactions and

Market participants investing in dynamic structures should evaluate carefully the record of the manager of the structured transactions, the nature of the manager’s discretion, and the potential for conflicts of interest. Key issues in this regard include triggers that call for or prevent certain actions, provisions governing the diversion of cash flows to various tranches, and the ability/right to substitute reference credits. In addition, market participants should encourage the rating agencies to continue their efforts to provide information that supplements the ratings themselves. Efforts to provide information on the events and scenarios that would lead to credit derivative ratings downgrades or information on ratings volatility are examples of additional information that could help market participants better understand the risks of such instruments.

 

2.4   Credit Model Risk, Correlations and Extent of Risk Capture

Corporate in Malaysia that rely on models to assess the valuation and risks of credit derivative instruments need to have sufficient staff and expertise to properly understand the assumptions and the limitations of those models, and to manage their usage appropriately. It is essential that the usage of such models be subject to periodic validation independent of the trading or business area, including independent audits conducted by capable internal or external auditors. Corporations need to undertake efforts to regularly compare model-based valuations with available market proxy that understand the role of correlation assumptions in models used for valuation and assess the extent of risk capture for routine risk measurement calculations.

 

2.5   Clearing And Settlement Arrangement For Over-The Counter (OTC) Credit Derivatives

The financial institutions need to extend the successful efforts to reduce confirmation backlogs in credit derivatives to other OTC derivative products, using automated systems whenever possible. To mitigate the risks of remaining backlogs, more systematic use of economic affirmations is appropriate and over time dealers should work toward daily portfolio reconciliations with their most active counterparties;

 

Conclusion

Reiterating the fundamental view that the wave of innovation underway in credit derivatives will offers substantial benefits to both the efficiency and stability of our financial system. The extent of these benefits will depend on market participants in Malaysia can keep up with the pace of change in the market through continued investment in both risk management and in the processing infrastructure. We have been through a period of relatively favorable financial conditions, and the prospect for future stability will depend in part on the degree of care and conservatism market participants bring today to judgments about opportunity and risk management.

 

References

1)       Angeloni, I., Kashyap, A. and Mojon, B. (eds.) (2003), “Monetary Policy Transmission in the Euro Area”, Cambridge University Press.

2)       Bondt, G.J. de (2004), “The balance sheet channel of monetary policy: first empirical evidence for the euro area corporate bond market”, International Journal of Finance and Economics, Volume 9, Issue 3, pp. 219-228.

3)       CGFS-BIS (2003), “Credit risk transfer”, Committee on the Global Financial System, January. Counterparty Risk Management Policy Group II (2005), “Toward greater financial stability: A private sector perspective”, July.

4)       Dfd De Nederlandsche Bank (2002), “Credit growth underestimated owing to increasing securitisations”, Statistical Bulletin, December, pp. 17-21.

5)       Donald L. Kohn (2007), “Asset-pricing puzzles, credit risk, and credit derivatives” Central Bank Articles and Speeches, March. Vice-Chairman of the Board of Governors of the US Federal Reserve System, at the Conference on Credit Risk and Credit Derivatives, Washington, D.C.

6)       ECB, “Credit risk transfer by EU banks: activities, risks and risk management”, May 2004.  ECB, “Assessment of accounting standards from a financial stability perspective”, December 2006.

7)       FitchRatings, Global Credit Derivatives Survey, September 2006.

8)       Geithner, “Implications of Growth in Credit Derivatives for Financial Stability”, President and Chief Executive Officer, Federal Reserve Bank of New York, 16 May 2006.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Development of Credit Derivatives Market and the Challenges in Malaysia

By Hanif Ghulam Mohammed

CIMB Investment Bank Bhd

 

Development

 

The credit derivative market has exploded the last few years in the international markets with volume doubling up each year. The most common form of credit derivatives is the Credit Default Swap (CDS). Based on the latest number as at Dec 2007 reported by BIS the amount outstanding on CDS is USD 57 trillion.  Only commercial banks in USA are required to report all derivative transactions. It remains to be seen whether banks worldwide are required as well to report to their national supervisory authorities on CDS transactions. Till then observers will have to rely on surveys carried out by rating agencies and BIS.

 

In Malaysia, according to a press statement last year there were a couple of CDS trades done involving Malaysian banks with the underlying reference entity being Projek Lebuhraya Utara Selatan (PLUS) bonds. There have also been talks of banks wanting to pass on credit risk to retail customers via Credit Link Notes (CLN). Banks can link deposits to specific credits and give out higher returns. Risk is transferable to retailers and if there is a credit event, retailers do not get their deposit back. Such structures have great benefits to bank risk profile and their ability to lend more. The essence though lies in proper documentation and information to willing customers of the risk involved.

 

The popularity of credit derivatives stems mainly from the fact that it remains the single most efficient tool to hedge a credit exposure. It allows banks to rid of exposures on its balance sheet simply with a swap thus exchanging the credit exposure to the trade counterparty usually rated much higher than the underlying credit itself. This is extremely useful especially when the underlying exposure is in the form of loans or illiquid bonds which in nature are hard to sell off and traditionally held to maturity. For some credits the notional outstanding amount on credit derivatives surpasses the actual outstanding bond amount for the credit.

 

It is a good platform for investors to get exposure to credits with bonds that are highly illiquid or not available in the market. This has ultimately changed the credit landscape with investors having options to reduce or expand and diversify their credit portfolios.

 

CDS premiums have become the best indicator of credit risk deterioration. More significantly credit derivatives have helped and will continue to help banks and investors to increase or reduce credit risk, diversify across sectors and manage a better overall credit risk portfolio.

 

 

 

 

 

Regulators

 

Credit derivates falls under the jurisdiction of International Swaps and Derivatives (ISDA). ISDA remains the definitive guide to standardized rules for derivatives.

 

Credit derivatives in Malaysia are regulated by Bank Negara Malaysia (BNM) as set by the Guidelines on Regulatory Treatment for Credit Derivatives Transactions dated September 2005. The guideline recognizes at least 4 credit derivative structures namely, CDS, First to Default Baskets (FTD), Credit Linked Notes (CLN) and Total Return Swaps (TRS).

 

Compared to the rest of the world, one should applaud BNM stance on credit derivatives which errs on the conservative but not restrictive approach. BNM allows banks to engage in credit derivatives for hedging, investment or trading but each proposal has to go thru BNM first under new product approvals.

 

The challenging years

 

One cannot mention credit derivatives without discussing the events of 2007, 2008 and furthermore. It is of no doubt that many books and theories will be written, right or wrong. Part of what went wrong was the amount of leveraging that went unchecked. It was CDO on top of a CDO sold to investors hungry for yield. The ripple effect that stared with subprime deterioration was compounded due to the leveraging. The product did not fail; those who sold protection or bought the securities were made to pay for their bad judgments. There are many who benefited in the process namely those who bought the protection.

 

Another intriguing development learned in this event was that counterparty risk is of extreme importance and financial institutions (F.I) should take greater care in their respective dealings. The guidelines on a defaulted counterparty are clear, should they be in receipt of gain, these gains are legally owed to them. On the other hand one has to queue behind creditors if there are losses owed.

 

The lesson is clear; the way forward for credit derivatives is further regulation which may lead to an introduction of an exchange to act as counterparty to all players. This can take away counterparty risk and regulate the credit derivatives market.

 

The Malaysian challenge

 

The conventional Private Debt Securities (PDS) market where traders trade OTC corporate bonds has evolved into an efficient playground for corporates to raise alternative funding. The Malaysian market is recognized worldwide as having the most number of Islamic bonds issued in the whole world with about RM 200 billion of Islamic issues. Players consist of real money asset managers, insurance and bank dealers. Ringgit PDS is traded on an absolute yield terms and credit spread is loosely derived from the absolute yield minus the appropriate tenor of Malaysian Government Securities (MGS) or absolute yield minus Interest Rate Swap (IRS). Whilst theoretically the spread seems fair, the actual movement in market dictates that the spread is moving due to the movement in the IRS or MGS. This form of pricing is heavily influenced by interest rate movements rather than actual credit factors.

 

In developed markets where there exists better liquidity, corporate bonds are traded on an actual spread terms thus eliminating the interest rate movement. This method of trading focus solely on credit risk thus promoting better risk management. This form of pricing is one of the reasons why credit derivatives can flourish. It provides a better gauge and understanding of the pricing.

 

Based on the understanding that credit spread provides the best form of pricing a credit, then the easiest way to price credit derivatives in Malaysia would come from the asset swap (ASW) level which on face value is the absolute yield minus the IRS level. As it is a derivative there is no funding need which leaves the spread above the ASW as the actual credit spread level. Thus actual pricing should remain close to that level minus market forces. However as many of those involved in the PDS market have various ways of managing their portfolios there will be different arguments to actual pricing level and this remains a stumbling block in the development of credit derivatives. 

 

The basic fundamental of any market is the fact that there needs to be a willing buyer and a willing seller. The credit derivative market is no exception to this rule. In the Malaysian PDS market, the buyers have always come from the asset management companies, insurance companies, mutual and pension funds. The sellers usually come from the banking fraternity.

 

Herein lies the problem when banks are looking to hedge off their credit risks. It is not clear if the real money buyers like the pensions funds are allowed to engage in CDS or credit derivatives as they do not fall under BNM umbrella. Even harder would be the asset management companies with various funds and answerable to the common public.

 

The lack of counterparties will make CDS trades harder as counterparties may not have avenue to square off trades.

 

Malaysia’s financial system is flush with liquidity thus the need for assets. Investors are always looking for assets and have not really looked at derivatives as a way to pick up yield. It is perhaps then wise to suggest a funded version of credit derivative to investors which are long cash. CLN provides a wider range of assets to invest and it entails taking in deposit against the Notes. This provides investors with an exposure to a wider range of names using up its excess liquidity and frees up bank’s credit limit to the credits involved.         

 

Another obstacle that needs to be addressed is transparency of trades. People are less keen to engage in a trade or any credit structure if there is lack of knowledge, prices and information.

 

Although BNM has done much to promote credit derivatives, one could suggest they go one better and allow netting of credit exposures with derivatives. Currently the guideline is quite strict in this respect requiring all details to be matched to the exact precision. Acquiring perfect hedges is usually rather impossible and almost all the time unprofitable. 

 

Essentially a CDS is transferring the credit risk of the underlying to the counterparty. When there is potential in counterparties defaulting, there exists a risk the CDS contract becoming null. This risk though should be mitigated from the onset through Credit Support Annex (CSA) and through diligent process of Knowing Your Customers and counterparties (KYC). This risk will exist in other products and is not specific to credit derivatives.

 

The key business for any Malaysian bank still remains in its loan departments. The perception that loans cannot be hedged should be corrected. Although loan is not a deliverable obligation under BNM ruling, this should not hinder progress as credit derivative contracts can be cash settled. Banks have the avenue to diversify and hedge their loan and bond portfolio and this advantage should be utilized.   

 

Ideas to launch the market

 

From the discussion above its clear there are challenges that need to be addressed to push credit derivatives in Malaysia. Improving price transparency will come about with greater participation. Exchange Traded Platform (ETP) and Fully Automated System for Trading (FAST) could also be a platform where contributors provide indicative pricing for the liquid CDS or structures. This can reduce pricing errors and even if there is discrepancy in pricing, it may not necessarily be detrimental to the market. Opinions and views drive the market.

 

Although internationally there has been no precedence, we should not overlook the idea of a clearing house for CDS in Malaysia. Moving from OTC to an exchange traded counter (ETC) can help bolster transparency and improve liquidity. The exchange can take over the neutral counterparty role on auctions to determine recovery levels. This idea will also limit potential impact on counterparty risk.

 

Regulators have an important role to play and have so far played a major part. Allowing netting of exposures to knock off single customer limit (SCL) will give credit derivatives a major boost to the credit market as a whole. Even partial netting would spark some movement allowing easier accessibility of funding to corporates, boosting production and in the macro perspective producing positive numbers on the economy.

 

 

 

 

 

New dawn

 

Credit derivatives allow public participation in the credit market. But as we have seen from recent developments, there has to be a strong message that with greater risk there is the possibility of loss on capital and onus is entirely upon the individual. The passing of information has to be clear and precise as possible.

 

There is a comfort zone that needs to be upgraded should we want to promote better stability in our financial market. Investors in Malaysia have leaned on the cautionary and traditional but not necessarily prudent approach for too long. They have been cash bond investors and although the approach has worked for many years, it has never been full proof to any potential defaults. Often when the situation arises, the investor is left to face workout options.  For the sharp eyed investor there exist an opportunity to profit from a potential default or even a negative credit event and the idea that an investor can make money only from a bull market can now be ridiculed.

 

Many of the better developments in Malaysian financial market have come through with collaboration with regulators. Although there have been pockets of development, there hasn’t been enough. Undoubtedly banks together with regulators, have to play the lead role as they as a group would stand out as major beneficiaries. The biggest prize will be reserved for the financial market in the form of greater liquidity, transparency and stability.     

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Development of Credit Derivatives and Challenges in Malaysia

By Adrian Wong Yew Chong

Bank Negara Malaysia

 

 

Introduction

           

            Global financial markets are facing unprecedented crisis since the Great Depression, due to the meltdown of sub-prime mortgages, on-going credit crunch and followed by the collapse of financial corporations which were thought “could never fail”.  Financial bailouts by the United States and European governments signify the severity of the current situation. The actions to save AIG from brink of collapse was a complete U-turn from US Treasury’s decision to allow Lehman Brothers to go bust, which was believed to stem another financial storm .e. crash of credit derivatives market.  Despite being touted as a financial ingenuity which has helped increase market efficiency, a failure in credit derivatives market can spark a chain-reaction leading to financial Armageddon. Perhaps it is now timely to relook at how such product came into existence, its development on a global scale and whether the Malaysian market will be able to embrace this product, which has fallen from grace in the eyes of investors.

 

Development

 

            Essentially, credit derivatives are bilateral financial contracts that isolate specific aspects of credit risk from an underlying instrument and transfer that risk between two parties. A buyer of a credit derivative is purchasing protection against credit risk of a reference entity, which could be a corporate, sovereign or any other legal entity that have incurred debt. One of unique point for these financial instruments is that the reference entity need neither be a party to nor aware of a credit derivative transaction. This confidentiality enables banks and corporate treasurers to manage their credit risks discreetly without interfering with important customer relationships.

 

As shown in Figure 1, the credit derivatives universe were developed by 3 “big bang” products i.e. credit default swaps (CDS), credit options and total return swaps. These three building blocks have spawned numerous other products that cater to investors’ whim and fancy. Such products can grow in complexity in terms of pricing and modelling, depending on whether the structure is derived from single-name or multi-name entities. Furthermore, these instruments can also be classified into two categories, i.e. unfunded and funded. The difference between the two is that an unfunded product will require the protection seller to make protection payments on happening of credit event, without recourse to other assets. CDS is an example of unfunded derivative, contrasted with a Collateralised Debt Obligation (CDO), a funded derivative generally known as a bond issued against a mixed pool of assets.

 

 

 

            Figure 1: Credit derivatives universe

                     Source: JP Morgan, Lehman Brothers

 

            The derivatives market has gone through an evolutionary life cycle, as identified by Charles Smithson (2003). The first “defensive” stage was the late 1980s and early 1990s, and was characterized by ad hoc attempts by banks to lay off some of their credit exposures. Stage two began about 1991 and lasted through the mid- to late-1990s, which saw the emergence of market intermediaries and investors entering the markets to seek exposure to credit risk. The third stage, which began in the late 1990s, saw the maturing of credit derivatives from a new product into a household name in the financial community.

 

            It is in this third stage that the credit derivatives market has really taken off. The market grew exponentially, from a mere USD180 billion in 1996 to an estimated USD33 trillion in 2008 (Figure 2). Improved market efficiency, standardized ISDA documentation and active market players (such as hedge funds) are important factors that led to such an explosive growth.

           

Figure 2: Growth of global credit derivatives

Source: Credit Derivatives Report 2006 – British Bankers’ Association

 

 

 

The passage of time has also shown how credit derivatives have changed as a mere hedging tool for managing credit risk to a traded instrument as part of profit generator. In Table 1, Banks remain the top buyer and seller of credit protection, whilst the participation of insurers has reduced somewhat due to entry of hedge funds, whereby their participation almost doubled in 2006 compared to 2004. Hedge funds use credit derivatives in a variety of ways, all of which tend to augment market efficiency and price discovery as well as to increase liquidity. Hedge funds can use credit derivatives in their convertible bond arbitrage activities in order to strip out unwanted credit risk and trade protection in order to profit from perceived mispricing.

 

Table 1: Credit derivatives product mix and traders by institutional type

2004

2006

 

2004

2006

Buyer

Seller

Buyer

Seller

Banks

67

54

59

44

Insurers

7

30

6

17

Hedge funds

16

15

28

32

Pension funds

3

4

2

4

Mutual Funds

3

4

2

3

Corporates

3

2

2

--

Others

1

1

1

--

 

100

100

100

100

Source: Credit Derivatives Report 2006 – British Bankers’ Association

 

Table 1 also shows that Index trades have surpassed single CDS in terms volume traded in the market. One the advantage of index trading is that it provided diversified exposure instead of concentrating it on one name, which was more appealing to investors. Furthermore, dealers took deliberate measures to promote liquidity in index trading. Such measures included the development of master confirmations, commitments to quote tight bid-offer spreads, and allowing investors to trade out of an old index and “roll” into the new one at mid-market spreads.

 

Challenges in Malaysia

            The growth of Malaysian credit derivatives market (CDS especially) has yet to catch up with the pace of the global market. In Malaysia, as well as the Asia Pacific, the CDS market still tends to be limited international investors. Due to the rating asymmetry by local and international agency, the demand for CDS differs among local and foreign investors. Domestic rated AAA corporations are often rated only A or BBB internationally, and international investors would thus be more interested in hedging the associated credit risks. Despite having one of the most developed corporate bonds in Asia, Malaysian investors still see little need for protection as the market is made up of highly domestic rated issues.

 

            Another challenge in Malaysia is the lack of names available for trading in the CDS market, which indirectly impairs market breadth and depth. Apart from the existence of a significant credit risk, the availability of the information about the entities is also a critical factor to allow a meaningful evaluation of risks. Large companies listed or major stock exchanges and owe significant amount of debts in foreign currency (e.g. USD) can enter the CDS market easily. In the case of Malaysia, the CDS market suffers a setback as most debt issuers in Malaysia are in the local currency and equities are primarily listed in Bursa. International investors are not particularly keen in trading local MYR CDS due to inadvertent foreign currency exposure. Nevertheless, Malaysia can boast of its inclusion and its locally incorporated entities into the iTraxx ex-Japan, a form of CDS Index swaps actively traded in global players (Figure 3).

                                                   

                                                    Figure 3: Components of iTraxx ex-Japan

                                    Source: Markit. com

 

            Furthermore, there is also a lack of information covered on this particular market in Malaysia. Disclosure of trades in CDS and other credit derivatives are rarely captured or not reported by financial institutions, which may lead investors to think that the local currency CDS market maybe non-existent at all! If a survey was taken, perhaps many investors would not even know that the first ringgit CDS was traded in June 2007, for an amount of MYR25 million and the reference entity was PLUS. Research indicates that both BNM and the Securities Commission also do not disseminate public information which details the activities of the credit derivatives markets, which also obscured the existence of this market.

 

Conclusion

            In retrospect, Malaysia can count itself lucky not to be embroiled in the credit crunch being faced by the developed economies. Due to sub-prime meltdown, products such as CDO’s and CLO’s, which formed part of credit derivatives universe, suffered tremendously and also magnified the current financial situation. However, this does not mean that the Malaysian market should do away with credit derivatives altogether. With proper regulatory oversight, implementation of best risk management techniques and ethical considerations, Malaysian capital market can be made much more efficient and liquid with the use of credit derivatives.

 

 

 

References:

1. BIS Quarterly Review, June 2008

 

2. David Mengle, Credit Derivatives: An Overview, ISDA, May 2007

 

3. British Bankers’ Association, Credit Derivatives Report, 2006

 

4. FinanceAsia.com, Citi trades first derivatives in Malaysia, 14 June 2007

 

5. Smithson, Charles. Credit Portfolio Management, Hoboken, New Jersey: Wiley, 2003

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Development of Credit Derivatives Market and the Challenges in Malaysia

By Fong Chee Choong

OSK Investment Bank Bhd

 

 

The current financial turmoil has given a timely insight into the known but yet complicated credit derivatives market which is largely credited for causing some of the biggest losses ever experienced in the financial market.

 

The widely publicized collapse of the subprime mortgage market, which undeniably triggered the so-called “financial tsunami”, was mainly attributed to poor credit controls and irresponsible lending practices on the part of the lending agents. However, a closer look unravels the fact that the massive losses and eventual closure of some of the well-known financial institutions in the likes of Bear Sterns, Lehman Brothers and Merrill Lynch was primarily due to their involvement in the credit derivatives market in the form of CDOs (Collateralized Debt Obligations) and CLOs (Collateralized Loan Obligations). These credit derivatives instruments which involve complex bond pools, have played a key role in the unfolding of the current credit crisis.

 

 

Credit Derivatives Growth

 

Credit derivatives which are mainly OTC (over-the-counter) contracts, has come a long way since the first derivatives instrument was introduced and traded way back in the early 1990s. The derivatives market remains one of the largest markets in the financial world with an estimated total outstanding contracts of USD523 trillion. Over the past decade, credit derivatives have been the mainstay of derivatives growth, accounting for approximately USD54 trillion of the total derivatives market, according to the latest figure reported by BIS (Bank of International Settlement) as of September 2008.

 

This extraordinary growth speaks wonder of the changing landscape in today’s financial instruments. Market participants are more sophisticated and ever willing to assume a higher risk-return profile through complicated leveraging credit structures. The globalization of the financial market also spurned further demand for credit derivatives instruments of such nature which are easily accessible from basic products like CDSs (Credit Default Swaps) and CLNs (Credit Linked Notes) to more complicated ones such as CDOs and CLOs, allowing market participants to assume credit exposures otherwise unavailable in the cash market. Alongside this, credit derivatives has evolved into speculative trading rather than used solely for commercial hedging or as investment instruments, where the value of contracts outstanding far outstrip the underlying assets many times over.

 

 

 

 

 

 

 

Challenges in the Credit Derivatives Market

 

The growth of credit derivatives is not without its fair share of challenges and obstacles. There are many wide-ranging issues concerning the interaction between credit derivatives and the cash market especially at times of a credit crisis. Over a short span of time, many market participants have invested or hedged their exposure via the use of credit derivatives. Accordingly, there has been a significant change and diversification of market participation beyond the traditional commercial and investment banks which now includes large insurance companies, hedge funds and government agencies. In times of financial distress, the multi-layered credit derivatives structures may provide an incredibly huge task in seeking covenant waivers from the debt holders and in identifying the relevant investor base. The more diverse the investor base, the more likely would there be differing or conflicting views on any proposed re-structuring of the underlying debt.

 

The other challenges relate to the standardization of legal documentation and the uncertainties in the operational aspects of credit derivatives, particularly in the occurrence of a credit event. To this end, ISDA (The International Swap and Derivatives Association) has issued standard credit definitions as well as settlement and novation protocols as guiding principles which have proven to be immensely useful in the development of credit derivatives, although the industry has yet to reach its desired state of operational standardization and efficiency. The outstanding issue of numerous confirmation backlogs and unauthorized assignments of contracts may jeopardize the legal comfort currently provided in these documentation standards. As noted, it still remains an enormous challenge for industry players and regulators to sort out the operational aspect of the post-trade settlement process and the legal implications of a default in respect to credit derivatives instruments.

 

 

Credit Derivatives in the Malaysia Context

 

In Malaysia, derivatives in general, have not flourished as much when compared to its development globally in terms of market size and usage. Popular structures are more commonly derived from the interest rate, foreign exchange and equity markets used for hedging of an underlying exposure or as an alternative investment strategy. Credit derivatives, thus far, has been mostly limited to interbank players where an initial party would sell protection on a single or multiple entities to earn an upfront premium or  a series of credit spreads payment. On another note, there have been a few noteworthy credit structures where banks would bunch a specific number of consumer loans to be sold as CLOs to interested investors.

 

As with any other developing markets, the slow growth of credit derivatives in Malaysia is essentially due to the lack of knowledge and understanding of the intricate mechanics of these instruments not only on the part of users but regulators alike. Moreover, previously encountered huge losses like the infamous Barings Bank and many others exposed the unusually high leveraging risks posed by derivatives instruments further caused many to shy away. Warren Buffet’s description of derivatives as “the financial weapon of mass destruction” also did its fair share of damage in the efforts to promote credit derivatives products. Albeit the ongoing struggle by the regulators to localized the standard credit documentation and protocols as defined by ISDA, the legal re-course remains unclear in a largely untested market environment.

 

The other real challenge lies with the weak and deficient risk management controls and infrastructure set-up. Few organizations possess the necessary resources and tools to measure and monitor the risk exposures inherent in these instruments. Although internal risk management systems may have improved substantially over the last few years, most organizations still face considerable challenges in aggregating and capturing concentrations in exposures to credit and other risks on an integrated scale generated across their diverse array of activities. It is also an unresolved matter with regards to the implication of structured credit instruments on efficient capital allocation within the financial institutions. This coupled with a high system operational cost has further undermined the development of the credit derivatives market.

 

The surge in demand for innovative and easy to understand credit derivatives structures has not helped in the liquidity aspect, where if it exist at all, is definitely scarce and costly. The shortage of market-makers corresponding to the low risk appetite and highly restrictive trading limits self-imposed by many financial institutions is ultimately the key reason contributing to the low market trade volume. In this respect, it is also acknowledged that not all types of credit derivatives structures can be dissected and hedged out perfectly. Hence, significant amount of risks may need to be warehouse internally. Regulators on the other hand have not made it easy, constantly imposing tough governing rules and guidelines, perceived as hindering market efforts to promote an active and liquid derivatives market.

 

 

What is needed to drive the Credit Derivatives Market

 

In retrospect and taking cue from the global market experiences, there are generally three critical areas of focus to improve and drive the development of credit derivatives market in Malaysia, namely, (1) improving market liquidity (2) enhancing risk management capabilities and (3) strengthening operational and documentation processes. The creation and availability of a large pool of expertise as well as an improvement in the sophistication level of the risk management process would inadvertently improve market liquidity as more market participants would join in the fray.

 

Financial institutions would also need to consistently display the ability and discipline to perform stress testing and scenario analysis in order to capture potential losses in adverse market conditions. In addition to this, the rules for disclosure of information need to be updated to suit modern day financial instruments aimed at promoting better market transparency which would help restore the trust within the fragile financial market.

 

 

 

 

 

 

Continuous initiatives by regulators are also extremely crucial, especially in efforts to strengthen the legal framework within which the standard credit derivatives contracts normally operate. The industry in general remains vulnerable to the legal enforceability of close-out netting and collateral arrangements in reducing counterparty risk. The need for a high degree of legal certainty regarding the validity and enforceability of such arrangements has long been reflected in the regulatory capital requirements under the Basel Capital Accords.

 

 

In Conclusion

 

The rapid development in credit derivatives and the growth of this market segment is an important feature of today’s global finance. Most notably, the credit derivatives market segment has probably been one of the most innovative and fastest-growing in recent years. However, the same cannot be said about the state of credit derivatives in Malaysia in terms of market size and level of sophistication.

 

Unquestionably, concerted efforts are required to actively develop and promote credit derivatives if Malaysia is to make any meaningful breakthrough in this market. Then again, financial stability and market confidence have to be first re-established as the credit crisis has sent a strong wave of risk aversion and inflicted unimaginable damage to the financial system with no end in sight to the current cycle of grief.

 

 

 

 

 

 


[1]       Malaysia Industrial Development Authority is the government’s principal-agency which was established to promote foreign and local investments in the manufacturing and services sectors. Website http://www.mida.gov.my

[2]     The Institute of Bank-Bank Malaysia (IBBM) established in November 1977 as the professional and educational body for the banking and the financial services industry in Malaysia, Institute Bank-Bank Malaysia (IBBM) is the leader in providing industry-focused training programmes and certifications. Website http://www.ibbm.org.my

[3]     The Bank Negara Malaysia (BNM). website http://www.bnm.gov.my. The increased uncertainty and volatility in the international financial markets led to higher volatility in the domestic financial market.

[4]     The Financial Mediation Bureau is an independent body set up to help settle disputes between consumer and  financial services providers who are its members. Website http://www.fmb.org.my

[5]     Source from Institute of Islamic Banking & Insurance (IIBI). http://www.islamic-banking.com

[6]     Source from Islamic Financial Services Board (IFSB). http://www.ifsb.org

[7]     Of this US$ 1.5 trillion of funds, US$ 250 billion constitutes of High Net-Worth (HNW) individuals.

[8]     There are six GCC countries include Saudi Arabia, Kuwait, Qatar, United Arab Emirates (U.A.E.), Bahrain and Oman.

[9]     It is crucial that this huge amount of fund is channeled towards productive use such as GCC infrastructure or economic sectors and other emerging economies.

 

[10]          The International Financial Services Board (IFSB) provides minimum guidance for effective regulation and supervision with prudential standards for Islamic financial industry to be followed across the globe.    

        http://www.ifsb.org

[11]      The General Council for Islamic Banks and Financial Institutions (CIBAFI). http://www.cibafi.org

[12]    The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) is responsible for developing accounting, auditing, ethics, governance and Shariah standards for the international Islamic finance industry. http://www.aaoifi.com

[13]     International Swaps and Derivatives Association, Inc (ISDA) http://www.isda.org; and International Islamic Financial Market (IIFM). http://www.iifm.net

[14]   ACI - The Financial Markets Association, was founded in France in 1955 following an agreement between foreign exchange dealers in Paris and London. http://www.aciforex.com

[15]   Islamic Equity Financing i.e. Musharakah is joint venture profit sharing, mudharabah is trustee profit sharing. Islamic Debt Financing i.e. ijarah is leasing, bai’ bithaman ajil is deferred payment sale, bai’ murabahain is deferred lump-sum sale, bai’ salam is salam sale, bai’ istisna is sale on order and qard hassan is benevolent loan.

[16]    The International Centre for Education in Islamic Finance (INCEIF) provides in Islamic finance, to develop talents including professionals and specialists who are much needed to sustain market competitiveness and to meet future challenges in the Islamic financial industry and offers Chartered Islamic Finance Professional qualification (CIFP) with students from over 40 countries. http://www.inceif.org

   The Islamic Research and Training Institute (IRTI) established by the Islamic Development Bank (IDB) in 1401H (1081) promotes research conforming to Shariah for enabling the economic, financial and banking activities in Muslim countries and to extend training facilities to personnel. http://www.iiibf.org

  The International Shariah Research Academy (ISRA) to conduct Shariah research on the contemporary Islamic finance issues which promotes active engagement and dialogue among global Shariah scholars into convergence of views from different jurisdictions.

[19]    The Islamic Financial Services Board reference to IFSB ED3 “Guiding Principles on Corporate Governance”.

[20]    The Employees Provident Funds website. http://www.kwsp.gov.my

[21]   For a thorough discussion of the value chain concept, see Botkin, James W., and Jana B. Matthews, Winning Combinations: The Coming Wave of Entrepreneurial Partnerships between Large and Small Companies, John Wiley & Sons, Inc. New York, 1992.

[22]     Vandell, Kerry E., “Improving Secondary Market in Rural America,” December 1996,pp.14-18.

[23]    While the value chain concept discussed by Botkin and Matthews focuses mainly upon entrepreneurial partnerships, the lessons they present bear directly on the chain of transactions inherent in a secondary market.

 

    The McKinsey Quarterly conducted the survey in January 2007 and received responses from 322 executives: 85 from the United States, 145 from Europe, and 92 from the rest of the world. Of the respondents, 112 held C-level positions.