VZCZCXRO9416
RR RUEHCHI RUEHDT RUEHHM RUEHNH
DE RUEHKL #1462/01 2700858
ZNR UUUUU ZZH
R 270858Z SEP 07
FM AMEMBASSY KUALA LUMPUR
TO RUEHC/SECSTATE WASHDC 0029
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHDC
RUEHGV/USMISSION GENEVA 1512
RUCNASE/ASEAN MEMBER COLLECTIVE

UNCLAS SECTION 01 OF 02 KUALA LUMPUR 001462 
 
SIPDIS 
 
STATE PASS USTR - WEISEL AND JENSEN 
STATE PASS FEDERAL RESERVE AND EXIMBANK 
STATE PASS FEDERAL RESERVE SAN FRANCISCO TCURRAN 
USDOC FOR 4430/MAC/EAP/J.BAKER 
TREASURY FOR OASIA AND IRS 
GENEVA FOR USTR 
SENSITIVE 
 
SIPDIS 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV MY
SUBJECT:  Islamic Finance in Malaysia Part 2: Obstacles and 
Opportunities 
 
REF: Kuala Lumpur 1429 
 
¶1.  (U)  Summary:  Malaysia is determined to become a global hub for 
Islamic Finance, and already accounts for two thirds of outstanding 
Islamic bond issuances (reftel).  However, at a recent conference in 
KL, financial experts discussed a number of obstacles holding back 
development of this niche market.  Chief among them was the 
inadequacy of the secondary market and the lack of Islamic 
derivative products.  Higher legal fees and complications arising 
out of the need for Sharia compliance were a burden as well. 
Nevertheless, the Malaysian government remains optimistic and 
content to have a pragmatic approach to development rather than get 
hung up on the need for a "purist" approach to Sharia compliance. 
End summary. 
 
 
Central Bank Governor Claims 
40% Annual Growth in Islamic Bonds 
---------------------------------- 
 
¶2.  (U)  At the 2nd Malaysian Islamic Finance Conference in Kuala 
Lumpur last month, Central Bank Governor Dr. Zeti Akhtar Aziz 
announced that Malaysia accounted for about two-thirds of 
outstanding Islamic bonds throughout the world, amounting to roughly 
US$47 billion in 2007.  High savings rates in Asia and the Middle 
East were driving demand, she said, resulting in an average growth 
rate of 40% per year in the scale of the Islamic bond market. 
 
How to Build the Industry 
------------------------- 
 
¶3. (U) While Governor Zeti focused largely on Malaysia's success 
with Islamic bonds, other speakers at the conference focused on what 
needed to be done to build the industry.  Malaysia's RHB Islamic 
Bank chairman Vaseehar Hassan urged Malaysian Islamic banks to 
venture overseas and establish links with Middle Eastern markets, 
while also calling for non-Malaysian banks to issue Islamic bonds in 
Malaysia. 
 
 
Still a Developing Capital Market 
--------------------------------- 
 
¶4. (U) Investors at the conference complained that the Islamic 
derivative market was inadequate, and that there was almost no 
secondary domestic market for Islamic products.  There are simply 
too few players and intermediaries, they commented, so most 
investors prefer holding their investments.  Moreover, few Islamic 
derivative products exist.  Some investors also accused banks of not 
being transparent in risk management due to the lack of Islamic 
derivatives for hedging purposes.  Similarly, international rating 
agencies have noted the difficulty in rating Islamic products as 
there are few products for benchmarking.  In the case of Islamic 
REITs (Real Estate Investment Trust), Moody's Representative 
Director Christina Maynes said it was very much a conventional REIT 
in Malaysia's case.  However, she commented that Middle Eastern 
investors generally preferred to invest in real estate directly. 
 
 
Double the Legal Fees 
--------------------- 
 
¶5. (U) Issuers complained about the difficulty and higher cost in 
coming up with Sharia-compliant products.  Legal fees essentially 
double with the added layer of a board of Islamic scholars who must 
adjudicate Sharia-compliance. 
 
Sharia-compliance a high bar to meet 
------------------------------------ 
 
¶6. (SBU) In addition, Sharia compliance is stringent:  in addition 
to the basic prohibitions, like alcohol, gambling, etc., income from 
interest and debt to asset ratios must be below certain thresholds. 
Ed Teather, Executive Director and Senior Economist for ASEAN 
Research, told ECONOFF that these kinds of requirements made Islamic 
finance theoretically viable for refinancing existing assets, but 
nearly impossible to finance a new initiative that exists only as a 
blueprint or a business plan.  In addition, he pointed out that with 
the current excess liquidity in the market it simply did not make 
economic sense for corporations to go to the added trouble and extra 
expense of issuing Islamic products. 
 
 
KUALA LUMP 00001462  002 OF 002 
 
 
Shortage of experts 
------------------- 
 
¶7. (U) Yet another barrier is a lack of skilled Islamic finance 
professionals.  Banking professionals are seldom proficient in 
Sharia, while Islamic scholars are seldom proficient in finance. 
The GOM is providing scholarships to Malays who want to study 
Islamic finance and has established a training entity funded and 
coordinated through the Central Bank.  The 2008 budget proposes to 
exempt expatriate Islamic finance professionals from paying income 
tax in an effort to attract more talent from the Middle East. 
 
Working Towards Becoming "Purely Islamic" 
---------------------------------------- 
 
¶8. (U) Islamic finance, as it is currently practiced, is not 
regarded as "pure" by many practitioners and scholars.  However, 
there is a general consensus among these experts on the need to 
build the industry until it can become independent of the global 
conventional finance system.  Until then, interest rates remain the 
fundamental benchmark for pricing and the mingling of Islamic and 
conventional assets will continue. 
 
¶9. (U) Islamic finance, which forbids charging interest, uses an 
underlying asset to structure a "trade" as a substitute for a loan. 
For example, a contract is written to buy a specific amount of wheat 
and then re-sell the wheat at a specified later date at a different 
price.  The price difference can be used to finance an entirely 
unrelated transaction.  The concept of the time value of money is 
ignored, and the difference between the purchase and resale price is 
attributed solely to risk.  A blind eye is turned to the fact that 
compensation for "risk" is equal to what a conventional bank would 
charge in interest, and this "risk" even can be compounded daily. 
Practitioners acknowledge this and other "impurities" in how Islamic 
finance is carried out, but hope that someday the industry will grow 
big enough to establish its own benchmarks. 
 
¶10. (SBU) The concerns of some practitioners go further.  Rafe 
Haneef, Citibank's Head of Islamic Finance for Asia, told ECONOFF 
that in order to truly practice Islamic finance, one had to be 
concerned about what the next customer did with the wheat even after 
the Islamic bank no longer held title to it.  The wheat could be 
sold for consumption, but once it had been used in an Islamic 
transaction, it should not be used in any interest-bearing 
transaction. He said this would be "like selling grapes to a 
winemaker." 
 
¶11. (SBU) Because the market for Islamic finance remains small, some 
mingling of funds is inevitable, as there simply are not enough 
Islamic financial products available.  "All roads lead to U.S. 
Treasury bonds eventually," explained David "Daud Abdullah" Vichary, 
a longtime Islamic finance practitioner and British national. As the 
same money gets circulated, it is impossible to shelter it from 
conventional finance, he told ECONOFF. 
 
Comment 
------- 
 
¶12.  (U) Whether or not Islamic finance will overcome its obstacles 
and become a major global industry remains an open question. The 
vision of its promoters is to tolerate a bit of un-Islamic 
"impurity" for now out of necessity, but to gradually move toward a 
"purer" form as the industry grows.  In Malaysia, with the 
government in an activist mode, the approach to Islamic finance is 
more pragmatic than pure, and it appears to be a growing reality. 
 
KEITH