The global Islamic bond market more than tripled last year and is continuing to grow at comparable speed. The market grew from US$1.9 billion in 2003 to over US$6.7 billion in 2004, according to ISI Emerging Market's Islamic Finance Information Service (IFIS). And with US$1.08 billion already issued in the first quarter of 2005 and deals worth US$5.1 billion in the pipeline, IFIS sees total issuance for the year exceeding that of 2004. Issuers from the UK, the Arab Gulf, Malaysia and Indonesia are at the top of the league tables, but it has been south-east Asia where action has been hottest.
Malaysia stands firmly at the top of the league table. At the end of 2004, Islamic bonds accounted for fully 43% of outstanding issues, both public and private, in Malaysia, where the growing infrastructure and utilities sector lead the charge. Sources say Malaysia's Jimah Energy Ventures plans to issue more than US$1.3 billion in Islamic bonds this year.
"Building on the strong foundations of a well-developed, comprehensive Islamic financial system and strengthening its international inter-linkages and thus its global integration, has enhanced Malaysia's potential to be an international centre for Islamic finance," says Zeti Akhtar Aziz, governor of Bank Negara, Malaysia's central bank.
Several government measures have helped in this regard, including the issuance of Islamic Treasury bills and new tax exemptions for non-resident companies holding certain types of Islamic instruments. Malaysia has also been a leader in setting standards for Islamic transactions. Late 2003 saw the Malaysian government join the International Monetary Fund and the Saudi-based Islamic Development Bank in a new Islamic Financial Services Board that will help formulate proposed standards.
"One of the key drivers in south-east Asia has been the very strong regulatory push there over the last several years," says Usman Ahmed, a director responsible for Citigroup's Islamic bond and loans business.
Malaysia is at the forefront in many ways, with a number of recent initiatives that have helped fuel interest in Islamic finance. The country has more than 20 local and foreign banks offering Shariah-compliant products and services, and is taking a growing share of the global market for Islamic finance. The central bank expects Shariah-compliant assets to make up 15% of the country's total, according to reports, up from over 10% today. The country has been a leader for at least ten years, since creating the first Shariah-compliant overnight interbank money market in 1994.
Zeti hopes these initiatives will make Malaysia a hub for Islamic financial services in the region: "The move to issue new licences and accord legal status to the existing Islamic banking operations of the conventional banks is expected to accelerate the positioning of Malaysia as an attractive Islamic financial hub to the international financial community."
In Indonesia, Shariah-compliant banking assets now stand at around US$1.48 billion, less than 2% of total assets, but will grow to around US$25 billion in the next five years, according to its central bank. With a population that includes more Muslims than any other country in the world, many bankers see great potential in Indonesia. Bankers in Sri Lanka, Australia and New Zealand have expressed interest in stepping up operations as well, and reports suggest the Saudi banks are also thinking of opening branches in south-east Asia to take advantage of the growing market.
New hunger
Part of the growth has been fuelled by liquidity from the Arab Gulf that has pulled back from western investments and the US in particular in the wake of the most recent Gulf war. But a new hunger among investors in general has also led to the emergence of a wider issuer base and fuelled interest in a broader array of instruments, including asset-backed securities and Islamic bonds. The Asian Development Bank has contributed to this trend, entering the Malaysian domestic market (along with the International Finance Corporation) and laying plans to issue local currency bonds in China, the Philippines and Thailand.
Growing calls for harmonization of standards also indicate the market is gaining acceptance, and the desire to smooth business transactions in Islamic countries is also driving some western companies increasingly to seek Shariah-compliant deals.
Reports are that HSBC Holdings' Indonesian HSBC Shariah unit is set on entering that country's Islamic finance market within the next 12 months. Other western banks, including Citigroup, have also been interested in entering the Indonesian market.
To some, the increasingly issuer-driven market is a sign that Islamic finance is at last outgrowing its niche status. A recent deal by Saudi mobile telecom company Etihad Etisalat raised US$2.35 billion using only Shariah-compliant instruments and finance structures.
More and more countries are getting in on the act as well. "Malaysia is already very familiar with it," Ahmed says. "Brunei or the Philippines or potentially even Singapore could be making a significant drive toward Islamic finance. Thailand and Vietnam, these are all places that could potentially have interest from investors, so it's relevant for them to consider this as a possible avenue for financing."
Islamic banks now control anywhere from US$250 billion to US$350 billion worldwide, according to the UK's Financial Services Authority, a figure that is growing 10-15% a year. About 70-80% of Islamic assets under management are funds deposited by individuals on the retail level and by high net worth individuals, depositing money in Islamically compliant structures with both Islamic and conventional banks, Ahmed says.
"A fully documented estimate of the market is one of the things the industry has been lacking," he notes. Ahmed subscribes to a lower growth figure, more in the 6-8% range. "What is clear is that it's not something that is just going to fade away," he says. "It is definitely becoming an increasingly mainstream activity both from an issuer's and an investor's perspective."
Far-flung interest
The growth of Islamic finance has given south-east Asian issuers more opportunity to tap funds from liquidity pools outside the region. In the Middle East, Ahmed notes, there will be up to US$25 billion in project finance needs over the next 18 to 24 months, and 70% of that will be debt finance. "Those projects will all need to have their Islamic tranches," he says. "Similarly, in south-east Asia, whatever infrastructure expansion is going to take place, whatever private growth is going to happen, it will all be able to benefit from this."
"It's a one-shot approach to tapping all sources of liquidity," he adds.
But part of the growth in south-east Asian markets can be accounted for as interest in Shariah-compliant instruments even outside Muslim countries.
In the UK, for instance, the country's first Islamic bank, the Islamic Bank of Britain, opened its doors in 2003, and Lloyds TSB currently plans to start offering Shariah-compliant bank accounts there.
The German state of Saxony-Anhalt became the first European sub-sovereign to issue an Islamic bond last year, tapping the market for US$133 million. And the US Treasury department appointed its own expert on Islamic finance last spring.