International favourite: A stable and growing market attracts local and foreign investors

All signs point to an impressive run for Malaysia’s capital markets. The benchmark index has recovered from the 2008 global crisis, repeatedly hitting all-time highs in 2012 and continuing to set records. With an initial public offering (IPO) from palm oil firm Felda Global on June 28, the second-largest in 2012 after Facebook, and the dual listing of IHH Healthcare, Asia’s largest hospital operator, on July 25, the IPO market is booming. Malaysia’s corporate bond market, meanwhile, remains one of the deepest in the region and a major source of domestic funding. In the short span of a few months, the country went from a mildly interesting advanced emerging market with moderately good performance to an international favourite with a safe haven reputation.

The country is now set to pivot from being a strong and well-regarded local market to a regional or even a global player. Under the First Capital Market Master Plan (CMP1), total market size (domestic debt securities outstanding plus Bursa Malaysia’s market capitalisation) tripled in size between 2000 and 2010 from RM718bn ($231.62bn) to RM2trn ($645bn). The capital market grew by 14% from RM2.12trn ($683.9bn) at the end of 2011 to RM2.4trn ($774.2bn) at the end of September 2012. The country wants to double that again under the Second Capital Market Master Plan (CMP2). This time, it aims to grow with an increased emphasis on internationalisation, diversification and efficiency. The various pieces have been put into place: the equity market, the bond market, robust infrastructure, the Islamic component and the regulatory framework. Now, Malaysia has to transition successfully and better integrate with markets elsewhere.

MAJOR EVENTS: Felda Global is by far the highlight of the year. Shares in the state-owned operator of palm oil plantations were sold into a weak market just about a month after Facebook’s disastrous IPO. Despite concerns that the transaction could encounter headwinds because of poor global sentiment, the offering was oversubscribed by about 6.75 times, with strong interest from institutions. Its success confirmed to issuers, investors and regulators that the local capital markets have the capacity to absorb giant IPOs. As of September 2012, Felda had a market capitalisation of about RM18.1bn ($5.8bn). The Felda deal came on the heels of a January 2012 issuance of a sukuk, or an Islamic bond, by Projek Lebuhraya Usahasama (PLUS). At RM30.6bn ($9.9bn) the Malaysian tollway company’s bond was the world’s largest sukuk offering ever. Like the Felda IPO, the transaction boosted confidence, demonstrating that local capital markets are liquid and efficient enough to handle just about any offering.

FINANCING TRANSFORMATION: Large stock and bond sales are vital because they help ensure the success of the government’s Economic Transformation Programme. Privatisations help the state raise money for its ambitious development plans, while a healthy bond market will enable corporations to finance the infrastructure necessary for modernisation. Without the capital markets to provide funds and carry some of the burden, the transformation programme might not be possible.

Malaysia already has a significant debt load, with its debt-to-GDP ratio above 50%. The funding needs through 2020 for the planned infrastructure alone have been estimated to be as high as RM160bn ($51.6bn), equivalent to almost 20% of GDP. The country cannot accomplish its goals using its own balance sheet and risks fiscal crisis if it tries. The success of PLUS and Felda demonstrates the markets may be able to bridge the funding gaps and Malaysia may be able to successfully re-balance its economy.

OTHER NOTABLE DEVELOPMENTS: The IHH Healthcare IPO was also important to the future of the country. Like the other transactions, the IHH sale was notable in terms of market demand. It was 130 times oversubscribed, attracted a number of major investors such as the Kuwait Investment Authority, the Government of Singapore Investment Corporation and the International Finance Corporation, and left the company with a market capitalisation of about RM25.6bn ($8.3bn). Like Felda and PLUS, IHH is state-related and its IPO is another example of the government lowering its stake in private enterprise to free up money for development. Before the share sale, IHH was 100%-owned by Khazanah Nasional, the country’s sovereign wealth fund.

CROSS-LISTING: More importantly, the transaction was a major step in the internationalisation of the Malaysian market. The 349m shares were sold in what has been described as the first concurrent Singapore-Malaysia listing. Trading in both markets and fungible between the two, the stock benefits from greater exposure and higher potential liquidity. Investors in Singapore and Malaysia have direct access to the shares. The unique structure is one of the first examples of successful regionalisation in the equity markets and demonstrates that a measure of ASEAN-wide trading can be achieved without significant changes in law or infrastructure.

The fact that IHH is a service company is of some significance. It suggests that the economy is re-balancing and beginning to experience success outside of its traditional mainstays of natural resources and exports. It also shows that achievements of economic transformation can be taken global, that in building a modern Malaysia the country can also support the establishment of national champions. AirAsia is another example. The service company grew organically, went international and raised capital along the way, using domestic listings, foreign listings, joint ventures and leasing arrangements.

EQUITY & DERIVATIVES MARKET: As of the end of 2011, Bursa Malaysia had 941 listed companies and a market capitalisation of RM1.285trn ($414.5bn), up from RM1.275trn ($411.3bn) a year earlier, and almost double the market capitalisation of 2008. The exchange featured 28 IPOs in 2011, down one from 2010, and reported average daily trading value of RM1.8bn ($576.8m), an increase from RM1.6bn ($507.8m) in 2010, but lower than the trading value recorded in 2007. Foreigners own 18% of the equity in the market and were responsible for 26% of the trading in 2011. Expectations are for the value of new listings in 2013 to be similar to that of 2012, if economic conditions remain the same. But the size of individual IPO transactions is not likely to be as large as the listings in 2012 of IHH, Felda and Astro. As of October 15 companies had gone public in Malaysia in 2012, with 13 companies listed on the Bursa main board and another two on the ACE Market.

The derivatives market is evolving and expanding. Since 2009, when the bourse started using a trading platform provided by the CME Group, activity is up 47%, while foreign participation increased from about 20% to 28% through the end of 2011. Changes have also been made to help ensure investor interest. For example, new contracts have been added and defunct contracts have been reintroduced. Market infrastructure also continues to improve. In July 2012, Bursa Malaysia introduced an enhanced central matching facility, allowing for end-to-end electronic matching between brokers and custodian banks. The exchange is also phasing out the use of the proprietary WinSCORE front-end brokerage system and allowing brokers to trade using any compatible open system. On the derivatives side, the exchange has just undertaken a full overhaul of its clearing and settlement systems in cooperation with the Korean Exchange and the CME Group. The new system will also incorporate real-time risk management.

BOND MARKET: The bond market is essential to the country's economic development and has gone from an insignificant and not very helpful corner of the capital markets to a central pillar of stability and capital formation. It grew from about RM170bn ($54.8bn) in size in 1997 to RM841bn ($371.3bn) in 2011, amounting to close to RM980bn ($316.1bn) by the end of September 2012. Malaysia’s bond market is the largest in ASEAN, both in terms of absolute size and as a percentage of GDP. The corporate bond market is deep, liquid and a primary investment target for institutional investors, such as domestic pension funds, banks, insurance companies and mutual funds. Malaysia is also home to the largest sukuk market in the world. As of September 2012, more than 60% of all sukuks outstanding had originated in Malaysia.

BOOSTING BONDS: The growth of the market was the result of a conscious effort to address some of the weaknesses in the capital markets that led to the 1997-98 crisis. One of the main problems then was a mismatch of assets and liabilities, specifically the use of banks for long-term corporate financing. The regulators decided to take aim at the corporate bond market and promote its growth. Primarily, this was accomplished by simplifying and clarifying the regulations for issuers so they could better know how to come to market and predict how long the process would take. Regulation of corporate bond issuance was also moved from Bank Negara (the country’s central bank) to the Securities Commission (SC). The result of these reforms has been a shorter and more predictable timetable for corporations.

Corporate bond issuance for the period from January to October 2012 hit a record level of RM106.6bn ($34.39bn), surpassing the previous issuance record of RM71.2bn ($22.96bn) during the calendar year of 2011. First-half 2012 bond sales totalled RM66bn ($21.3bn), including the PLUS sukuk. Funds raised in the bond and sukuk markets totalled RM100bn ($32.26bn) at the end of September 2012, surpassing the 2011 total issuance record of RM70bn ($22.58bn). International investors are enthusiastic. Foreigners owned 21.55% of Malaysian local currency bonds as of September 2012, up from 19.75% earlier. The rate of foreign ownership of local currency bonds is the second highest in the region. In Indonesia, foreigners own 29.55% of rupiah bonds outstanding.

The development of infrastructure, especially infrastructure related to power and transportation, has been a major driver of the bond market. In some years, half of all private sector bonds were for infrastructure projects. The supply of new bonds is forecast to remain high as the country builds rail lines, roads, airports and ports to maintain competitiveness, pursue the goals under the Economic Transformation Programme and stimulate the economy despite weak global demand.

MERGERS & ACQUISITIONS: The consolidation in the banking sector has not been matched in the brokerage industry. Some rationalisation has taken place since 2000, when the country had 60 brokerages, but the SC still had 37 establishments on its list of qualified securities dealers as of June 2012. According to Kaladher Govindan, the head of research at local brokerage TA Securities, the industry is ripe for consolidation. “The country has too many brokers, and it is very difficult for many of the smaller shops to compete with the large, integrated banking groups,” he told OBG.

In May 2012, Malaysia-based investment holding company RHB Capital acquired the investment banking arm of OSK Holdings, creating the country’s largest stock broker in a move that was seen as an attempt to challenge the investment banking arms of Maybank and CIMB and develop a regional footprint. The transaction, valued at RM1.95bn ($629.1m), brings RHB a new presence in three markets – Indonesia, Hong Kong and Cambodia – and enhances its capabilities in Singapore and Thailand.

Another domestic merger is in the works. K&N Kenanga Holdings, 16.6% owned by Deutsche Bank and the country's sixth-largest broker, has been in talks to acquire ECM Libra Financial Group's stock trading and investment banking unit, the ninth-largest brokerage operation in Malaysia.

Other mergers and acquisitions in brokerage and investment banking were more aimed at regional expansion than domestic consolidation. Maybank acquired Kim Eng Holdings in May 2011 to gain a foothold or expand its operations in ASEAN markets. In April 2012 CIMB acquired most of Royal Bank of Scotland's Asia-Pacific units for RM849.4m ($274m). As a result of the transaction, it gained presences in Taiwan and Australia and was able to add to its operations in Hong Kong, India and China.

REGIONAL INTEGRATION: Regional integration is a major theme these days in the Malaysian capital markets, and a number of initiatives have been undertaken to promote and enhance regionalisation. The ASEAN Trading Link, which became partly operational in 2012, is designed to allow investors to directly trade on other markets in ASEAN member states. The first leg was between Singapore and Malaysia, which started offering linked services in September. Thailand is set to join in October, with Indonesia and The Philippines to be added later.

Then in March of 2012, a memorandum of understanding was signed between Malaysia, Singapore and Thailand to allow for expedited reviews of cross-listings. The idea is to reduce to 35 business days the time it takes for a company already trading in one market to become listed in another signatory nation. Currently, this process can take as long as 16 weeks.

With respect to market infrastructure, Malaysia recently signed several cross-border memoranda of understanding with Thailand and Singapore. Under this arrangement, financial institutions will be able to obtain local currency from their central bank by pledging cash, sovereign debt or central bank securities from another country which makes itself party to the agreement. Malaysia has also continued to expand its links with Hong Kong.

Since 2006, Bank Negara has had a system in place for settling interbank ringgit-US dollar trade transactions with the Hong Kong Monetary Authority (HKMA). In March 2012, this connectivity was improved to allow more efficient cross-border debt settlement with HKMA and Euroclear Bank, a Belgium-based financial services company that specialises in the settlement of securities transactions.

Most importantly perhaps is the establishment of the Credit Guarantee & Investment Facility, being set up and capitalised by the Asian Development Bank and the ASEAN+3 group, which includes China, Japan and South Korea. The $700m fund will guarantee corporate bonds in the region, allowing some countries to access longer-term financing that might not otherwise be available to them.

CONCENTRATION: Despite the health of the Malaysian capital market as well as the soundness of its infrastructure, there are some concerns about the market’s structure. While the brokerage sector is not as concentrated as the banking sector, competition may be limited. The major institutional investors remain for the most part large and conservative. They crowd into the highest-rated paper, generally ignoring anything under AAA or AA. The high-yield market is of little interest to pension funds and other larger pools of capital because their charters largely prevent them from buying anything not investment grade.

Some institutions are beginning to seek ways to break away from the pack. The high-grade corporate bond market is not providing the returns needed as yield spreads are narrowing. Managers of large pools of capital are forced to find ways to enhance their portfolios. “Fixed income is not giving fund managers the best of returns, and the equity market is too volatile. Therefore portfolio strategy teams are looking at stronger diversification into other asset classes such as commodities, private equity and alternative investments,” Azian Mohd Noh, the CEO of Kumpulan Wang Persaraan, which manages the government’s pension fund assets, told OBG.

INFRASTRUCTURE FINANCING: The infrastructure bonds have also raised questions. The World Bank has expressed some concerns regarding the provision of government guarantees, explicit and implicit, when the private sector undertakes large projects. This may be a particular problem in Malaysia, where the lines between public and private have long been blurred. The government at times provides subsidies when a project has a social benefit but provides returns too low for the developer. Malaysia’s sovereign debt has nearly doubled over the past five years and the debt-to-equity ratio is approaching 55%, the second highest in the region. If the private sector and the corporate bond market are used to finance public programmes and the debt created is in some way guaranteed by the government, the real debt load could become critical.

The Ministry of Finance estimated in 2010 that government guarantees are equal to 12.2% of GDP. “Although not all the guarantees will crystallise over time, the sizable amount points to the urgent need for the government to commit to a medium-term fiscal sustainability framework so as not to repeat the lessons so evident from the current eurozone sovereign debt crisis,” Yeah Kim Leng, the group chief economist at RAM Holdings, told OBG.

OUTLOOK: Malaysia has spent more than a decade working to strengthen its capital markets and related institutions following the 1997-98 crisis, and now it finds itself in a leadership position. The country remained the IPO capital of South-east Asia for 2012, and in all likelihood will remains so for longer, with its bond market continuing to grow and complement the equities market. The challenge now is to take this strong foundation and build on it. This may not be so easy. It will not simply be a matter of more and bigger listings. The country will need to begin to broaden its capital markets so that a wider range of clients can get funding and so investors can achieve higher returns. However, authorities recognise these issues and are opening markets more to outsiders who may bring technology, knowledge and talent. If Malaysia succeeds in making this transition, it stands to improve overall returns and keep its regional leadership role.

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The Report: Malaysia 2012

Capital Markets chapter from The Report: Malaysia 2012

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