Moving right along: Tepid interest in some segments, but the market is stable overall

While the possibility of loose monetary policy ending in the US raised concerns in the Malaysian markets, 2013 turned out to be a strong year for new offerings and for the benchmark index. In the end, the effects of changes in the US were not as pronounced as feared and money flowed into Malaysia from elsewhere; 2014 also started on a good note. It also turned out that the markets in Malaysia were stronger than expected and underlying demand for equities remained. There were some notable disappointments, such as the AirAsiaX initial public offering (IPO), and some worrying delays, such as an 1Malaysia Development (1MDB) subsidiary listing. But overall the market performed well, with a good number of offerings and an index that kept rising despite some moments of doubt. Considerable progress was made in terms regulation and supervision as well.

IPOSs

Malaysia recorded 17 IPOs in 2013, just as it did in 2012, according to Bursa Malaysia statistics. In the first six months of 2014, nine IPOs were reported by the stock exchange. In 2013, RM8.2bn ($2.56bn) was raised in IPOs. That was considerably less than the total in 2012, when the exchange raised RM22.9bn ($7.15bn), up from RM6.7bn ($2.09bn) a year earlier. The 2012 numbers were skewed by one exceptionally large offering, the RM9.93bn ($3.1bn) sale of Felda Global Ventures shares. The palm oil producer came to market in June of that year in what was the second-biggest offering globally in 2012 after Facebook. IHH Healthcare, which came to market in July 2012, was also quite large, at RM6.3bn ($1.97bn).

Malaysia had some large transactions in 2013, but nothing like those in 2012. In October UMW Oil & Gas sold RM2.36bn ($737.56m) in shares, while Westports Holdings sold RM2.24bn ($699.1m) of shares the same month. But these issues were nothing like the massive sale of Felda Global Ventures.

Deals Delayed

At the same time, 2013 lagged a bit due to the delay or cancellation of some deals. Ranhill Energy, an oil and gas company, had been scheduled to do a transaction in July 2013. However, the deal was delayed due to a dispute with Petronas. According to local press reports, the Malaysian state oil company cancelled a licence held by one of Ranhill’s subsidiaries. The licence allowed the subsidiary to bid for Petronas jobs and the loss of the licence was material to the company’s accounts.

Power Plays

Malakoff, Malaysia’s largest independent power producer and a subsidiary of transport firm MCC, has repeatedly delayed its IPO. It was first supposed to go public in the fourth quarter of 2012, but that deadline slipped because of problems in preparing the filing, according to the Wall Street Journal. Its 2013 listing was also put off due to maintenance work on a power plant, according to company statements. An International Financing Review article in early 2014 said that the deal would not happen until 2015. The IPO is said to be worth $1bn.

In May 2014 1MDB delayed the listing of its power subsidiary. A report in the Star newspaper said that the IPO might not happen until 2017. The company later said that the transaction could occur in the second half of 2014, according to Bloomberg. 1MDB had purchased a number of power generation assets, and the plan was to use the proceeds from a listing to pay down the debt taken on to buy these power assets. Delays in increasing power output have pressured the company to rethink the timing of the IPO, according to the Star, and rely on short-term funding from its bankers to tide it over in the meantime.

Convenience store chain 7-11 Malaysia also had some trouble coming to market in 2013. It had to cancel its offering in November due to objections from the Securities Commission. According to press reports, the regulator was concerned that the company had gone private in 2011 and was coming back to the market just a few years later at a much higher price. The Securities Commission mandates that companies that are listed after being taken private justify any large change in pricing. The convenience store’s transaction finally got off the ground in May 2014 with a respectable $226m share sale.

Listing Momentum

Other than 7-11, a number of solid deals have come to market, and there was considerable listing momentum in the first half of 2014. The year got started on a strong note with the IPO of IOI Properties, which raised $580m. In May, Boustead Plantations sold $330m of shares in the largest offering of the year to that point, and in late June Icon Offshore sold $295m of shares.

Early in the year, Affin Bank estimated 15 public offerings for 2014 and a total of $8.1bn raised (though the estimate included 1MDB). In addition to the already successful IPOs, other expected offerings include: Iskandar Waterfront, Medini Iskandar, the Axiata Group’s tower assets, aviation firm Weststar and MOL Global, an online payments company. Ranhill Energy may also make an attempt to list again.

Some international deals are also anticipated for 2014. Felda Wellness International, a wholly owned subsidiary of Felda Global, has said it is planning a public offering on Nasdaq in 2015, for example.

Mixed Performances

While most transactions have done well, some have languished. Astro Malaysia Holdings, an entertainment company which listed in late 2012, debuted unchanged and has performed poorly since its $1.5bn offering. AirAsiaX also had a weak first day and has been sluggish since its $313m IPO in July 2013. The airline’s shares opened unchanged at RM1.25 ($0.39), despite support from Maybank, and fell to RM0.695 ($0.22) in the space of a year. Market conditions have been choppy at times while investor sentiment has been variable as global economic conditions and monetary policy in the West continues to challenge the markets of South-east Asia.

Bond listings have been strong but off of their highs of a few years ago. In the first quarter of 2014, a total of RM30.7bn ($9.58bn) of corporate bonds were issued, which is about the same as in the first quarter 2013 but down significantly from the same period of 2012, when issuance reached RM50.5bn ($15.76bn). As well, bonds outstanding as a percentage of GDP have come down slightly, from a record high of 106.22% in December 2012 to 103.83% in December 2013 (and 103.06% in September 2013).

Most of that can be explained by a drop in government bond issuance as the country butts up against its sovereign debt limit (and fights off suggestions that it may be the next Greece). Banks also say that large corporations are so cash-rich that they are not much in need of the bond markets for financing.

Regulatory Advances

Overall, the market is seen as large, growing, healthy and strong. In 2013 the capital markets grew 10.5% to RM2.7trn ($842.67bn), with RM1.7trn ($530.57m) in equity and RM1trn ($312.1bn) in debt, according to data from the Securities Commission. The commission notes that a total of RM94bn ($29.34bn) of paper was issued and that assets under management in the fund management industry rose by 16.5% to RM588bn ($183.51bn). Corporate governance is generally well rated. In the ASEAN Corporate Governance Scorecard Country Report and Assessments 2013-2014, Malaysian publicly listed companies were number two in ASEAN, behind those in Thailand and ahead of those in Singapore. Because of the market’s strengths and good reputation, the Securities Commission has proposed establishing a regional centre for the International Organisation of Securities Committees in Malaysia.

Reforms

A number of reforms have been made that are relevant to the markets. In December 2013, a month earlier than scheduled, Bursa Malaysia upgraded its trading engine, utilising NASDAQ OMX technology. Bursa Trade Securities 2 replaced a 2008 system. The new engine is 1000 times faster in terms of trade execution than the old engine, has 10 times the processing capacity and will help to improve risk control.

The biggest change in the sector is the passing of the Financial Services Act. According to accountancies and law firms, the act promises to significantly alter the landscape of the financial industry. It aims to makes sure the financial institutions are strong and that their managements are qualified and fit for their positions. The act grants the central bank extraordinary powers in terms of its ability to influence staffing, operations, and mergers and acquisitions. It is significant in that it covers all companies operating in the finance sector and allows the central bank to intervene in their operations if it feels as though they pose a risk to the financial system in general.

Brokerage Mergers

The country has been encouraging brokerage mergers for a number of years. In 2009 the government said it would allow foreign investors to own 70% of brokerages, a significant step up from 49%. Still, consolidation among these firms has been slow. The total number of brokers has dropped, but only slightly, from 37 in 2009 to 33 in 2014. RHB Investment Bank and OSK Investment Bank completed their merger in early 2013, and their newly formed entity is now rebranded as RHB-OSK. In April 2014 Affin Holdings acquired the investment banking and brokerage assets of HwangDBS in a deal worth approximately RM1.36bn ($424.46m).

Through June 2014, HwangDBS was number one in terms of trading volume handled, with a share of 14.5%, while Affin had just 2.34%. In value terms, HwangDBS was number five, with an 8.33% market share, and Affin was ninth, with a 3.69% share. The leaders in value terms are CIMB, with 11%; RHB, with 9.59%; and Maybank, with 9.4%. While brokers are hesitant to merge, commission rates have fallen to levels where it is becoming difficult for the smaller firms to survive and for all firms to properly fund research.

Derivatives

In October 2013 Bursa Malaysia started offering a gold derivatives contract. While the use of derivative securities has increased, with the overthe-counter (OTC) market growing from RM338m ($105.49m) in 2003 to RM1.3trn ($405.73bn) in June 2013, their use remains fairly limited in terms of the types and risks of the contracts. According to an IMF study in early 2014, the use of financial derivatives rose significantly after the unpegging of the ringgit from the dollar in 2005. Structured products also became more popular as interest rates fell and as savers tried to get higher returns from balances. The IMF adds that most of the contracts were related to foreign exchange and most contracts are also “plain vanilla” in style. Credit default swaps were rare, it said, and bank exposure to derivatives was low.

The regulators have tried to get a better line of sight into this potentially opaque market, but some of their efforts have been difficult to implement. In late 2013 the Securities Commission, Bursa Malaysia and the Perbadanan Insurans Deposit Malaysia, the deposit insurer, issued a paper outlining reporting requirements for OTC derivatives transactions. According to the new rules, almost all OTC contracts must be reported to the trade repository. But according to bankers, this might be difficult, as some counterparties may be in different jurisdictions and revealing their names could violate the banking and privacy laws of these other jurisdictions. The reporting is going to have to be fast, at T+1, and extensive, with documentation, margin and collateral information.

Challenges

A number of challenges remain. Some analysts point out that Malaysia’s markets face certain limits because of the lack of internationalisation. Foreign investors are certainly very active in terms of total ownership and trading in the market. Foreign institutions traded 26.32% of Bursa Malaysia shares and foreign individuals traded 19.32% in June 2014. But as a place for listing, the exchange remains fairly local in nature. According to the World Federation of Exchanges, Bursa Malaysia has just 10 foreign listings, up from four a decade ago.

Unlike the markets of Hong Kong and Singapore, and even Nasdaq, London’s AIM or the Toronto Stock Exchange, Malaysia’s exchange doesn’t attract the same level of interest from regional investors. The IPO boom of recent years has largely been the result of the listing of giant local firms and on the investment of local funds, primarily from the massive pensions. Unless Malaysia becomes more of a nexus for international offers, an upward limit remains on how big the market can ultimately grow. The country also lacks a critical mass of international investors resident in the country, thus limiting the amount of on-the-ground research and global exposure in the market.

Malaysia has been trying to develop the relevant capacity for a number of years. In 2006, for example, the listing rules were amended to allow companies with no assets in Malaysia to list locally. In 2009 XingQuan International Sports Holding, a Chinese company, took advantage of the liberalisation and started trading on the stock exchange. In 2009 the listing requirements were dramatically altered, and the Malaysian market went from being merit-based to disclosure-based. This reform made the Malaysian market more attractive to foreign companies because the route to listing was clearer.

Since the change, many foreign listings have come to the market, but the foreign stocks that have listed so far have not done well in Malaysia. Trading has been light, prices have dropped and the shares have largely been shunned by investors. While the market is sound and the listing rules are now conducive to foreign companies, Malaysia is not the most intuitive place for non-Malaysian companies to list.

In addition to competition for listings, competition for capital remains intense. Singapore has faced a penny stock scandal that is making it less attractive as a place to invest for the time being, but investors have a great many options in East Asia and globally, and Singapore is taking measures that will in time restore confidence in the market.

Recently, China has emerged as an IPO threat as well. New issues had been weighing on the stock market and Chinese regulators had been trying to boost the index by limiting new supply. Companies are cash-strapped and in need of funding, though, so IPOs were allowed again; after a four-month break, the country’s regulators lifted the ban on new listings.

With an estimated backlog of some 460 companies, the region faces a significant overhang in listing demand. The competition for capital is thus only going to increase as these companies come to market.

Larger economic pressures remain on the financial system. Inflation is starting to kick in, and that is having an impact on the financial markets. In May 2014 the rate was 3.2%, and was as high as 3.5% earlier in February. In its May 2014 meeting, the central bank kept its overnight policy rate at 3% despite the signs of inflation. The bank could raise rates later in 2014 or 2015 at the latest due to strong economic growth and rapidly expanding credit. Rates may also need to increase if the US Federal Reserve starts tightening money and that leads to an outflow of investor funds.

A rise in rates could challenge the markets as credit gets more expensive for businesses and consumers. Other concerns for the bourse include high household debt, high sovereign debt, and high levels of off-balance-sheet government debt, all of which are starting to weigh on the economy and bring into doubt the country’s prospects, despite sound fundamentals and a good outlook for growth.

The Link

Regionalisation has been slow in developing. ASEAN remains highly fragmented in terms of trading, market infrastructure and connectivity, and Malaysia’s links to other markets remain rudimentary and underutilised. The ASEAN Trading Link was formed in late 2012 and very quickly three exchanges joined: Malaysia, Singapore and Thailand. But since then, none of the others have signed on; Indonesia said in June 2014 that it was not ready to be connected to the rest of the region. ASEAN Trading Link may be having problems, much like its Chi-East predecessor, because it is not a total solution. It concentrates on the high-level deliverables but ignores the important infrastructure that needs to be thought through and built. The peer-to-peer model was chosen because it was politically acceptable and easy to establish, but critics note that without a core platform and a clearing system of its own, the Link is not very interesting to investors. For instance, brokers in ASEAN have said that the Link is not of much practical use to them and their clients as they still have to settle manually with their counterpart broker in the other market.

Some progress has been made recently. In April 2014 Deutsche Bank was appointed to provide custody and settlement services for the ASEAN Trading Link. Still, the member countries have to agree on some significant market infrastructure before the system handles meaningful volume.

Outlook

As in much of the region, Malaysia is facing headwinds related to changes in monetary policy in the West and the tapering of quantitative easing. Foreign investment will likely become more volatile going forward. Nevertheless, Malaysia is well positioned not only to weather any difficulties ahead, but it is in a good position to outperform. It has a well-regulated market, a strong domestic investor base, both institutional and retail, and its listed companies are well governed. Malaysia will remain a preferred target for international investors even if the Asia markets go out of favour because of higher rates in the West. The IPOs are likely to continue and Malaysia should perform well in the competition for capital.

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The Report: Malaysia 2014

Capital Markets chapter from The Report: Malaysia 2014

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