Edmond Lau, Executive Director (Monetary Management), Hong Kong Monetary Authority
Good morning ladies and gentlemen,
1. First of all, I would like to thank the organiser, REDmoney group, for giving me the opportunity to speak here today at the Hong Kong Islamic Finance News Roadshow. I would also like to give a special welcome to those overseas speakers and participants who have travelled to be here. This is the third time that the roadshow is being held in Hong Kong and it is encouraging to see the continued large turnout, which is a testament to the strong interest of market participants here in Islamic finance.
Recent global developments
2. Over the past two years, the global Islamic finance market has experienced rather difficult times brought about by the onset of the global financial crisis in 2008 followed by Dubai World's standstill announcement at the end of last year. Inevitably, given the increasing integration with the mainstream financial system, the Islamic financial industry cannot be insulated from the effects of the global environment and has been adversely affected by the global financial downturn. But it has demonstrated good resilience and lent itself quickly to the recovery of financial market conditions that started last year. The sukuk market, for instance, rebounded remarkably in 2009 with total issuance reaching about US$23 billion, representing an increase of 56% from 2008.1
3. The global financial crisis aside, the fallout from the Dubai World incident has also shaken investor confidence towards the Gulf region and in the viability and sustainability of Islamic finance. But look at the Dubai World incident just a little bit beyond the initial knee-jerk reactions; you will see that it is in fact an isolated event. It is a credit issue that is applicable to both conventional and Islamic markets, and has nothing to do with the inherent structure of sukuk. For all these reasons, we have started to see a gradual improvement in investor sentiment and tentative signs of revival of activity in the sukuk market. We believe that once there is a clearer view on the outcome of Dubai World's debt restructuring, the sukuk market may rebound more strongly.
Strategic position of Hong Kong in developing Islamic finance
4. Against the backdrop of these global developments, I would like to reiterate here that the commitment of the HKSAR Government to develop Islamic finance in Hong Kong remains intact. The development of Islamic finance is a long-term initiative which would not, and should not, be affected by cyclical factors or individual credit events. Indeed, over the past year or so, we have been working hard to lay down the necessary groundwork for accommodating Islamic finance in the city.
5. I know that some people are still sceptical over what role Hong Kong can play in Islamic finance given the relatively small Muslim population here. Let me now take this opportunity to share our thoughts on how Hong Kong can contribute to the further development and growth of the global Islamic finance market.
6. For many years, Hong Kong has been serving as a centre for international financial intermediation, matching investors and fund-raisers from different parts of the world. As a free and open economy, Hong Kong has developed a highly liquid capital market with a large presence of international banks, well-established financial infrastructure, a transparent regulatory framework, a sound legal system and a simple tax regime. The fact that we have a small economy has never been a hindrance to us in establishing a firm foothold in conventional finance. Likewise, a small Muslim population is not expected to deter us from developing a platform for Islamic finance, simply for the fact that Islamic finance has already gained widespread recognition, not just among the Muslim community, but also among other investors who see it as a new asset class.
7. With all of our many strengths, we see great potential for Hong Kong to develop a wholesale Islamic capital market as a first step in developing Islamic finance, taking on a financial intermediary role on an international scale. In other words, we are positioning ourselves as an international platform which efficiently channels savings into investment across jurisdictions. In taking on such a role, we specifically see that Hong Kong can become a niche market facilitating fund flows between the Middle East and Mainland China.
8. On one side, the Middle East has huge investment needs arising from an abundance of oil-driven liquidity. Benefiting from the buoyancy in oil prices over the past few years, the oil-rich GCC countries have been receiving a large amount of oil revenues, resulting in a vast accumulation of wealth in the region. According to estimates made by the Sovereign Wealth Fund Institute, the combined total assets under management of sovereign wealth funds of GCC countries amounted to about US$1.4 trillion at the end of March 2010, representing more than one-third of global sovereign wealth funds and nearly one-fifth of global foreign exchange reserves.
9. The large pool of oil money has generated a considerable demand for investment which cannot be satisfied within the region alone. Many Middle East investors are now actively looking for investment opportunities beyond their domestic borders. Traditionally, the advanced economies have been the destination of choice for the bulk of this money. But since the global financial crisis, investors looking to increase their returns have begun to diversify their investments into potentially higher-yielding assets from the emerging markets of Asia, and especially Mainland China.
10. On the other side, there are huge funding needs in Mainland China for economic and infrastructure development on the back of rapid economic growth and massive industrialisation. Over the past 20 years, total infrastructure spending on the Mainland has been going up every year. The 11th Five-year Plan laid out the Mainland authorities' intent to invest a total of US$1 trillion in infrastructure projects during 2006-2010, more than double the amount in the previous Five-year Plan. Going forward, it is generally expected that infrastructure spending and the associated funding needs will remain high in Mainland China in the course of continuous economic development.
11. This gap between the financing and investment needs of Mainland China and the Middle East presents remarkable opportunities to Hong Kong. As an international financial centre and a gateway to Mainland China, there is no better time than now for Hong Kong to capitalise on this trend and tap into this niche market by positioning itself as a premier gateway for Middle East investors to access investment opportunities on the Mainland.
12. In fact, Hong Kong has been a key fund-raising centre for Mainland enterprises, and possesses the largest, deepest and most open Chinese capital market outside of Mainland China. By the end of 2009, the stock market in Hong Kong was the seventh largest in the world by market capitalisation, with over half of it being populated by Mainland-related stocks.2This has offered investors unparalleled access to a wide range of investment opportunities in Mainland China, whether in real estate, commodities, energy, transportation, or telecommunications. Thus, the development of Islamic finance capabilities is just a natural extension of Hong Kong's role, providing a new and viable fund-raising alternative to prospective Mainland issuers while extending their reach to potential Islamic investors in the Middle East.
Facilitating necessary infrastructure
13. In order to achieve such a goal, it is necessary for us to remove any impediments to the development of an Islamic capital market in Hong Kong so that Islamic capital market products would not be disadvantaged from a commercial viability point of view. For Islamic equities and funds, the existing regulatory and taxation framework can readily support their development. You may in fact be well aware that there have been successful launches of Islamic equity indices and Shariah-compliant funds out of Hong Kong in the past two years or so.
14. Nevertheless, as far as sukuk are concerned, taxation has been one of the major impediments for their development in Hong Kong. In terms of economic substance, sukuk are no more than debt securities. But because of the more complex structure of sukuk, which often involve the transfer of underlying assets and the setting up of special purpose vehicles, the issuance and trading of sukuk in Hong Kong may attract additional tax implications in terms of profits tax, property tax and stamp duty when compared with conventional bonds, hence putting sukuk at a disadvantage. It is therefore necessary to align the tax treatment of sukuk with that of conventional bonds.
15. Currently, the Government is in the process of drawing up a legislative proposal to modify the tax regime so as to provide a level playing field for sukuk vis-à-vis conventional bonds. Specifically, the areas to be addressed include profits tax, property tax and stamp duty. Given the fast pace of financial innovation and market development nowadays, it would be nearly impossible to cater for all the different types of sukuk in the legislation. Therefore, in the initial stage of this legislative exercise, the focus will be on four types of sukuk, namely ijarah (leasing), musharakah (joint venture), mudarabah (profit-sharing) and murabahah (cost-plus). These are four of the most common types of sukuk and together, they account for more than 90% of total global sukuk issuance from 2001 until 2007.3 If appropriate, more sukuk structures and Islamic financial products may be catered for in the future.
16. Similar to the UK, the Government intends to adopt a prescriptive and religion-neutral approach in the legislative amendments, with the salient features of the relevant sukuk types clearly spelled out in the legislation as the qualifying criteria for tax neutrality purposes. Financing arrangements which satisfy these criteria will enjoy the relevant tax neutrality treatments without the need to seek prior approval by market players. In this way, we hope that more certainty and clarity can be provided to the industry, hence encouraging development of the sukuk market.
17. The proposed legislation would help level the playing field for issuance and trading of sukuk. However, drawing reference from the experience of other countries, it is not expected that the sukuk market will flourish overnight after removal of the impediments. Ultimately, the development of a sukuk market is industry-led and it is up to market participants to grow and develop the Islamic business here.
Multi-pronged strategy in developing Islamic finance
18. Necessary infrastructure aside, we are also putting considerable efforts on various fronts, including raising our international profile and linkages, promoting human capital development, and encouraging product development in the course of promoting development of Islamic finance in Hong Kong. Let me highlight the progress so far in these few areas.
19. First, on raising international profile and linkages, considerable progress has been made. As a relative newcomer to the industry, we recognise the need to learn from the experience of other established centres and co-operate with them to grow the market. We are therefore keen to pursue strategic partnerships with other Islamic financial centres like Malaysia. Just last year, a Memorandum of Understanding was signed between the Hong Kong Monetary Authority and Bank Negara Malaysia in September, with both parties agreeing to strengthen co-operation in the area of Islamic finance, particularly on the development of human capital and financial infrastructure, and the promotion of cross-border financial activities. The Hong Kong Securities and Futures Commission also entered into a mutual recognition agreement with the Securities Commission of Malaysia last November to facilitate the cross-border offering of Islamic funds.
20. You may ask why we are so keen to co-operate with other Islamic financial centres given that they could be deemed our potential competitors in the global Islamic financial arena. Well, I would say that the development of Islamic finance in individual economies is not a zero-sum game. It is true that some financial centres have already made a head start, while others are still catching up. But every economy has its own strengths and niches. Only by leveraging on each other's strengths can we create synergy and grow together.
21. Second, on human capital development, there is no doubt we are facing a shortage of Islamic market practitioners as with many other jurisdictions. We therefore attach great importance to education to deepen the knowledge and raise the awareness of market players about Islamic finance, thereby nurturing a larger talent pool in Hong Kong. The Treasury Markets Association (TMA) has been playing a significant role here by providing education programmes and organising a series of workshops and seminars on Islamic finance. In collaboration with TMA, we are currently in close dialogue with other Islamic financial centres like Malaysia to explore how we can strengthen co-operation in this regard. Several co-operative initiatives are now readily taking shape.
22. Last but not least, much effort has been put into encouraging product development. Market response has been positive. In the past two years or so, we have witnessed the launch of Islamic funds, Islamic equity indices, Islamic syndicated loans and so on. There are also three exchangeable sukuk listed in Hong Kong, one of which is linked to the underlying shares of a Mainland company listed on our stock exchange. The positive response to this sukuk reaffirmed the keen demand for investment opportunities in Mainland China through the Hong Kong platform. In addition, we are also glad to have seen the setup of two Islamic banking windows in the city. The increasing number of banks undertaking Islamic banking activities will definitely add further momentum to the development of an Islamic capital market in Hong Kong by providing important tools for funding and liquidity management.
23. Ladies and gentlemen, in the past ten minutes or so, I have briefly described how Hong Kong can position itself in developing Islamic finance and given you a brief update on what the Government and the regulatory authorities in Hong Kong have been doing to promote the development of Islamic finance here. The Hong Kong Monetary Authority will continue to give full support to the Government on this. As a market facilitator, we will continue to put in place the necessary infrastructure to maximise our readiness to cater for Islamic financial activities. But ultimately, the pace of development of Islamic finance in Hong Kong will be market-driven. Your presence here today is already an indication of the amount of interest and potential in this new business. I would like to urge you to gear up and get ready for the opportunities ahead of us. With this, ladies and gentlemen, let me wish the roadshow a great success and all of you a most productive day.
24. Thank you.
Standard and Poor's.
2 Sources: World Federation of Exchanges and Stock Exchange of Hong Kong.
3 Sources: Standard and Poor's and Zawya.