Malaysia's efforts to create a market for ethical Islamic bonds (sukuk) are the latest in a series of government-led initiatives to develop Islamic finance, but further expansion will require a greater buy-in from a sometimes reluctant private sector.
Malaysia has been at the forefront of innovation in Islamic finance, but a reliance on state-linked firms to launch new products could be a weak spot if the sector is to grow beyond such government patronage.
In May, sovereign wealth fund Khazanah Nasional launched the country's first sustainable and responsible investment (SRI) sukuk, nearly two years after the format was first announced by the government.
"Until now, nobody has done it. If we don't take this challenge, then I don't think anyone would be doing it," Khazanah's Chief Financial Officer Mohd Izani Ghani said in a phone interview.
"We have done many firsts before and it is always challenging," said Izani.
Last year, $74.9 billion worth of sukuk were issued out of Malaysia but only $13.5 billion came from corporate issuers, according to data from Zawya, a Thomson Reuters company.
There is little sign of this changing soon. Major issuers of sukuk this year include Petronas, Telekom Malaysia and Axiata, all of which are majority or fully owned by the government "Corporate sukuk issuance will remain dominated by government-related issuers," ratings agency Moody's said in a research note in May. "We expect this trend to continue for the remainder of 2015 as Malaysian government-related issuers continue to tap and further deepen the Malaysian sukuk market."
COMPLEXITY
This presents a dilemma for the broader Islamic finance market: how to widen the appeal of the sector with new structures, while ensuring enough volume for existing ones.
The new structures aim to appeal to first-time issuers but they can add complexity and costs.
The SRI sukuk from Khazanah will fund 20 new government schools and has a novel "step-down" feature where coupon payments will be reduced up to 100 basis points from their fixed rate if the schools meet certain benchmarks.
Private-sector firms could shy away from issuing their own SRI sukuk due to the additional resources required to establish and track such a structure, said Azdini Nor Azman, head of fixed income at Asian Islamic Investment Management.
The step-down feature should be revised to boost its attractiveness, said Azdini.
Other sukuk formats have struggled to get wider traction. Khazanah has issued sukuk in an exchangeable structure but this has yet to be used by a non-government issuer.
Axiata issued a reminbi-denominated sukuk in 2012, a year after a similar deal from Khazanah. But since then, no other firms have issued sukuk using that currency.
