Islamic Capital Markets in Asia, Emerging Challenges and New Entrants
Speeches
25 Jun 2008
Islamic Capital Markets in Asia, Emerging Challenges and New Entrants
Edmond Lau, Executive Director (Monetary Management), Hong Kong Monetary Authority
(Keynote Address at the 2008 London Sukuk Summit)
Good morning ladies and gentlemen.
- It was a great pleasure for me to be invited to speak at the
2008 London Sukuk Summit. Hong Kong is among the newest members of
a growing group of financial centres seeking to introduce Islamic
finance into their mainstream financial systems. I was particularly
happy for this opportunity to share our thoughts on positioning
Hong Kong for the emerging opportunities of Islamic finance and the
challenges in developing this new business from the Asian
perspective.
- The remarkable growth prospects of Islamic finance in global
financial systems have been extensively discussed in the past
decade and are now recoginsed globally. This new wave of capital
flows began with the oil-rich nations in the Middle East seeking
financial products elsewhere in the world that comply with the
tenets of Islam. In recent years, such flows have become
increasingly associated with Asia.
- The total capital flow into Asia may not be easy to quantify,
but it is obviously reflected in the growing trade relations
between the Middle East and Asia. According to the IMF, two-way
trade flows between the Gulf Cooperation Council nations of Saudi
Arabia, Bahrain, Kuwait, Oman, Qatar, and the UAE, and Asia
excluding Japan, have expanded four times in the past decade to
US$22 billion in 2006. That represents an equivalent of 15%
compounded annual growth, a reflection of the close economic
connection between the GCC and Asian economies.
- Providing a strong impetus to the growing interaction between
the Middle East and Asia is the rising price of oil and the
resulting accumulation of wealth in the Islamic world. The growing
desire for portfolio diversification away from traditional
asset-management centres has also fuelled the search for local and
regional investment opportunities. The sustained high growth in
Asia, underpinned by China's emergence as one of the world's major
economic powerhouses, has obvious attractions for Middle Eastern
liquidity seeking investment opportunities.
- And it appears that what we are seeing now is just the
beginning. According to a survey conducted by the Economist
Intelligence Unit on behalf of the Qatar Financial Centre, 59% of
Middle East financial-service professionals said that they expected
a significant rise in Islamic finance products in the next three
years. Over 20% of the correspondents also indicated that they
expected the Asia Pacific region to attract the largest portion of
equity investment among their Middle East clients. These figures
clearly reflect the growing interest of Middle Eastern investors in
the Asian financial economy. The survey also suggests that
diversification has become a real issue.
- Market potential aside, considering how far these demands have
been met by our financial markets so far, it is astonishing that
the global Islamic finance industry, which is estimated to be worth
US$1 trillion, is dwarfed several times over by the potential new
demand generated every year. Standard & Poor's estimates that
the current size of global Shariah-compliant assets to be worth
US$400 billion, which is equivalent to roughly 10% of the GDP of
the nations in the Organisation of The Islamic Conference or OIC.
It also estimates that the potential market for Islamic financial
services is close to US$4 trillion. The Islamic finance industry,
however substantial it already is, has not been accelerating fast
enough to match the growth in Islamic wealth. The development of
Islamic finance therefore calls for new entrants into this market
and needs to take on a new dimension of promoting greater financial
intermediation across jurisdictions in different regions.
- This is why Hong Kong is seeking to become an important player
in the booming Islamic finance arena by providing a platform for
Middle East investors to access investment opportunities in the
Asia Pacific region. In the opposite direction, Hong Kong can also
leverage on its experience, innovation and market diversification
to serve as a capital-raising centre for Middle Eastern issuers to
tap the funds made available by the high savings rate in the
region, in particular China. As a frontrunner in international
finance, which possesses key strengths in financial intermediation
on an international scale to bring together investors and fund
raisers from different parts of the world, Hong Kong can, and
should, likewise take on the intermediary role for Islamic
financial products, just as it currently does for conventional
products with a high degree of sophistication across all asset
classes.
- With only a small Muslim population, some people have
questioned how Hong Kong could play a role in these segments of the
market. But market players in Hong Kong have answered this
scepticism by quickly introducing our first Shariah-compliant
product. In late 2007, shortly after the Chief Executive of the
HKSAR unveiled the government's policy of developing Islamic
finance in his 2007 Policy Address, we witnessed the first Islamic
fund introduced by a local bank in Hong Kong. The fund tracks the
performance of the Dow Jones Islamic Market China/Hong Kong Titans
Index. In May this year, a new Dow Jones Islamic Market Index was
launched to track China-related equities listed in the Hong Kong
stock exchange, further enriching the Islamic index infrastructure
in Hong Kong. These initiatives clearly demonstrate the dynamism of
Hong Kong's financial systems in responding to an emerging market
opportunity.
- As mentioned earlier, it is a fact that Hong Kong's Islamic
community is not big, but we are confident that the development of
Shariah-compliant financial markets can take off even in
environments in which the domestic Islamic community is relatively
small, simply because investors nowadays are looking beyond
domestic boundaries and traditional finances as financial
activities gravitate towards the Middle East and China. Indeed Hong
Kong's relatively small population does not seem to undermine in
any way our performance in the conventional financial and capital
markets. Therefore we are not positioning ourselves as a market
that can match the supply and demand of Islamic products from a
domestic angle. Our objective is to make Hong Kong a platform for
the wholesale Islamic financial activities.
- What makes Hong Kong a natural destination for Islamic funds is
our deep and highly liquid capital markets. Almost all of the most
actively traded financial instruments are available for exchange in
Hong Kong, and this gives Islamic investors a much wider choice of
where to place their funds.
- More importantly, when it comes to investing in China, Hong
Kong is the obvious choice. Hong Kong has the largest and deepest
Chinese equity and debt markets outside Mainland China. We are the
first and remain the only major international financial centre that
has banking business and financial products related to the
renminbi. The development of a local renminbi bond market which
started in the middle of last year has firmly positioned Hong Kong
as a proving ground for China's continuing financial market
liberalisation.
- International investors can readily gain exposures to different
sectors of China through the Hong Kong platform. For example,
investors wanting to access China's property market can make use of
the Real Estate Investment Trusts listed in Hong Kong with
underlying exposures to properties in Mainland China. There has
also been encouraging innovation in combining sukuk with China
equity exposures. The successful launch earlier this year by a
Malaysian issuer of an exchangeable sukuk linked to the underlying
shares of a Mainland China company listed on the Hong Kong stock
exchange is a case in point. The exchangeable sukuk attracted a
high subscription from Middle Eastern investors and reaffirmed the
keen demand for investment opportunities with China growth
prospects through the Hong Kong platform.
- As I mentioned earlier, the Islamic financial sector has huge
headroom for growth and needs new entrants. In Asia, there is no
shortage of financial centres wanting to get into this market.
There are some financial centres which have already gained a head
start and there are some others which are fast catching up. We
believe this is not a zero-sum game as we can all grow together
with an ever larger Islamic financial market and benefit from the
greater efficiency, diversity and stability of a deeper capital
market. Hong Kong is therefore committed to working in close
collaboration with other markets in Asia to establish a deep and
integrated Islamic capital market in Asia. Admittedly this is no
easy task as we have not yet been able to do this for the
conventional capital market.
- Financial integration in Asia, as compared to international
financial integration generally, is probably less developed.
Financial integration refers to the mobilisation and channelling of
savings into investments across jurisdictions rather than just
domestically. Asian economies have probably lent more individually
to, for example, the United States, than they have collectively to
other Asian economies. Yet, more than half of the total trade in
Asia is intra-regional, reflecting that Asia is becoming
increasingly economically inter-dependent. Relatively speaking, our
financial relationship is underdeveloped compared with our economic
and, in particular, trade relationship.
- Given the current state of financial integration in Asia, the
development of Islamic capital markets involving cross-border
movement of funds is challenging as it has to address many of the
existing impediments to greater financial integration in the
region. But Islamic financial intermediation could provide a strong
catalyst for change and growth in the Asian capital markets, many
of which are now awakening to the potential for Islamic finance to
leapfrog developments in capital markets. So there are both
challenges and opportunities in this process.
- In the next few minutes, I'm going to analyse some of the key
elements that are needed to strengthen financial intermediation and
developing Islamic capital markets in Asia.
- The first is the establishment of links
between jurisdictions across the whole spectrum of financial
infrastructure - the trading, payment, clearing and settlement and
custodian systems for money, debt and other financial instruments,
since these provide the basic infrastructure for the movement of
savings between jurisdictions and make cross-border transactions
more efficient. Just like conventional instruments, Islamic capital
markets will benefit from an efficient and effective network that
reduces or removes uncertainties and risks in clearing and settling
financial transactions. The availability of a coherent and
effective financial infrastructure network is also conducive to
market development.
- A valid example of such linkage co-operation is the settlement
link between Hong Kong and Malaysia enabling instantaneous transfer
of US dollar-ringgit foreign exchange transactions and US
dollar-denominated securities lodged with the central bank of
Malaysia. The payment-versus-payment (PvP) and
delivery-versus-payment (DvP) links established between Hong Kong
and Malaysia have helped strengthen integration of our financial
markets. Imagine if a US dollar-denominated sukuk is to be launched
in Malaysia, targeting investors in Asia and Mainland China who
have a certain portion of their wealth managed in Hong Kong. By
striking the deal and initiating settlement locally, we can have
funds transferred electronically to the issuer in Malaysia and
securities credited to the investors in Hong Kong in synchronised
manner using the DvP mode. This sort of transfer can take place
locally with a high degree of certainty (in terms of finality of
settlement) and efficiency during Asian business hours.
- The second element relates to the relaxation
of non-supervisory restrictions, where they exist, on access by
foreign financial intermediaries to the domestic markets. We are
beginning to see some efforts made by jurisdictions in this region,
such as the mutual recognition agreement between the Malaysia
Securities Commission and Dubai Financial Services Authority (DFSA)
for the cross-border marketing and distribution of Islamic funds
between the two countries. Hong Kong has already established a
framework of co-operation with the Dubai International Financial
Centre (DIFC) Authority to look at market facilitation measures
including possibilities of removing non-supervisory restrictions on
Islamic capital instruments.
- The third element concerns the harmonisation
of standards in the financial system. Islamic finance has given new
meaning to harmonisation and standardisation. Not only is there a
need for market harmonisation of standards on a practical and
operational perspective with regards, for instance, to product
structures and legal contracts, but also another layer of
harmonisation attributable to the regulation and supervision of
Islamic finance products. Regulatory harmonisation is an imminent
issue for new entrants such as Hong Kong in shaping the
architecture for Islamic finance, particularly in relation to the
establishment of a taxation framework to provide a level playing
field for Islamic financial transactions. As there is not yet
convergence of a global standard on Shariah compliance, different
countries seem to have adopted different approaches in defining the
standards for Shariah-compliant products in determining, for
example, the granting of tax neutrality treatment. In Singapore,
the relevant regulations require the endorsement of the relevant
financial product by a Shariah board or committee of the issuer or
arranger. In Malaysia, the authorities have even set up a national
Shariah Advisory Council for approving all Shariah instruments,
thereby harmonising the standards at least within the country. In
the UK, the law describes the salient features of different types
of Islamic financing arrangements without a specific reference to
Shariah or any religious label for the purpose of granting tax
exemption. The onus seems to rest on the issuer or arranger to
satisfy himself that the requirements of the law can be met without
the need for an approval mechanism. The policy choice of each
jurisdiction is determined having regard to its own circumstances
and there is no hard and fast rule in determining an optimal
solution. Hong Kong is reviewing its tax law with a view to
providing tax neutrality to Islamic financial transactions and will
take into account the experience of other financial centres in this
regard.
- The forth element concerns the strengthening
of regional co-operation. Whether on a bilateral basis or in the
context of a multilateral initiative, strengthening dialogue and
stepping up regional co-operation can expose regulators to
developments elsewhere in the region and create an environment
conducive to a higher degree of regulatory harmonisation. There is
also scope for further development to increase the diversity of
financial intermediation channels in individual jurisdictions in
the region and for sharing experience in development efforts. This
explains why Hong Kong has committed itself strongly to the efforts
made by international organisations like the Islamic Financial
Services Board (IFSB). The Hong Kong Monetary Authority has become
an associate member of the Board which enables us to take part in
international dialogue and make reference to prudential standards
and guiding principles established by the Board for the Islamic
financial industry.
- The fifth element is the need for greater
capital mobility in general. It is hard to advocate lifting all
restrictions on cross-border investment as this would depend on the
ability of the financial systems in individual jurisdictions to
cope with the ensuing risks. However, it is apparent that greater
capital mobility is the necessary condition for financial
integration across jurisdictions. The relaxation of controls on
cross-border transactions can drive more efficient allocation of
resources. It is also a mark of financial openness crucial to the
attraction of global players in entering into Islamic finance
businesses in local markets in Asia. Ultimately this should be
conducive to the development of a larger capital market with
greater breadth and depth.
- Last but not least, the sixth element is the
need to nurture a larger pool of talent with expertise in Islamic
finance. Significant strides have been made over the past few years
in Islamic finance, but the talent pool is too small to meet global
needs. As a new entrant, Hong Kong has to leverage on the expertise
of the major international banks in other parts of the group in
structuring Shariah compliant financial products. But in future, we
will have to deepen the market knowledge within Hong Kong about
Islamic finance products. In this regard, the local industry bodies
such as the accounting association and treasury market association
can play a significant role by providing a forum for open and
useful discussion and the sharing of experience by experts in this
field, thereby enhancing the knowledge of all market players.
- This morning, I have briefly described how a new entrant like
Hong Kong could contribute to the development of Islamic finance
and outlined a few macro issues that the Islamic capital markets in
Asia are currently facing, with the objective of drawing greater
attention and efforts to addressing those issues. For the purpose
of promoting the stability, integrity, diversity and efficiency of
financial intermediation across jurisdictions in Asia, it is
crucial that Asian markets work more closely together to seize the
opportunities brought by Islamic finance. As a result, Asia will be
in a better position to benefit from a higher retention of savings
in our own region. The greater stability and efficiency in capital
flows in the region will also enhance diversification and integrity
of financial markets in Asia.
- Thank you very much.