Currency jitters

With currency wars brewing, corporates in the region have grown more nervous about their currency exposures. An HSBC survey in the third quarter of importers and exporters in the region shows that currency exposure has become an overriding concern.

The slide of the US dollar, the currency in which most trades are denominated, means Asian exporters are receiving less for their goods, although in some cases the weaker dollar can translate into cheaper raw materials.

Of the Vietnamese traders polled by HSBC, 76% – a 26 percentage point (pp) jump from the previous quarter – viewed their foreign exchange (FX) risks as worrying, citing fears about the impact on trade growth and demand. In Hong Kong, mainland China and Australia, respectively 62%, 49% and 45% expressed concerns.

This was before the announcement of the US Federal Reserve during its September policy meeting which opened the door to a second round of quantitative easing (QE), compounding concerns over the direction of the US dollar.

Liz Ann Sonders, chief investment strategist at Charles Schwab, explains that when the US Federal Reserve purchases assets, it credits the account of the seller in electronic dollars, thereby “printing” money. By expanding the supply of money, the Fed is devaluing the dollar. “Although a weaker dollar will benefit US exports in the short term, it translates into higher commodity prices worldwide,” explains Sonders.

“Since exports represent a mere 12% of the US gross domestic product and consumer spending 70%, the hit the US consumers take by rising commodity prices could outweigh the benefits to US exporters,” says Sonders.

“While the US dollar slides, other countries are unwilling to sit idly by and allow their goods to become more expensive.”

Obstacles to smooth trade

Simon Constantinides, Asia-Pacific head of trade and supply chain at HSBC, feels it is only natural that entrepreneurs are preoccupied with inherent risks, such as FX and trade regulation. The focus on currencies will intensify in the coming months, as rhetoric on protectionism and unfair trade practices reach a crescendo – especially at the G20 summit meeting on November 11 in Seoul.

While at the time of the HSBC survey, monetary authorities in the region were holding the harness as far as an interest rate hike was concerned, in the fourth quarter China and Singapore changed tack and raised interest rates.

Constantinides notes that corporates face a multitude of issues which hinder the smooth and profitable flow of goods. He cites the lack of infrastructure in parts of Asia and the emerging world; the rise in the costs for shipping, logistics and storage; the squeezing of profit margins by demands for higher wages; and the higher factory operating costs in the region. Around the world, the survey reveals, the following factors were cited as cause for concern: (i) cost of shipping and logistics, by 40% of respondents in Saudi Arabia, 21pp more than in the previous quarter; (ii) insufficient profit margins by 37% of those in the UAE, a 16pp rise; and (iii) supplier risks related to meeting trade commitments by 24% in Germany, an 11pp rise and 14% in the US, a 6pp rise.

New global trade paradigm

As the US dollar declines further in value and a US economic recovery is not assured, corporates in the region are changing the way they conduct business. While the US dollar remains the undisputed trade settlement currency globally, more regional traders expect to settle larger volumes in renminbi in the next six months: 56% in Hong Kong, 49% in Malaysia and 24% in mainland China. Those exporters and importers who plan to use the renminbi as their primary currency in the next six months, made up 19% in Hong Kong, 17% in Singapore, 10% in Indonesia, 7% in Vietnam, 3% in Australia and 1% in India.

Trade between Greater China and Asia continues to perform robustly, notes Chris Lewis, HSBC head of trade and supply chain for Greater China, and the fast-paced developments in renminbi internationalization is creating a shift in the region with greater exports and import volumes expected to be settled in renminbi. Emerging markets continue to drive global trade confidence but developed markets are showing increased optimism, Constantinides points out, and the positive market means trade will remain a major driver of economic growth globally. The new global trade paradigm will be increasingly characterized by stronger prospects of emerging markets trading with each other and the developed world finding more opportunities to stimulate trade with the emerging world markets.

This was published in the December 2010 issue of The Asset

Hedging liquidity risks in China

Concerns in late 2009 and early 2010 that a further souring of the global trade environment could jeopardize the ability of Chinese companies to honour their payment commitments to suppliers dissipated somewhat when global trade volumes recovered in a major manner, even if problems in more developed economies have persisted.

But Chinese firms continue to face challenges, as the government introduces macroeconomic measures with a view to addressing imbalances.

Peter Wong, the founding chairman and president of the International Association of CFOs and Corporate Treasurers (China) discusses with The Asset the various ways in which corporate treasurers across the country are coping and how best they can hedge the risks facing their companies.

Is China suffering from a major credit crunch?

The credit availability may be tight for certain industries, such as real estate, where excessive price escalation is to be curtailed. The fundamentals of China remain solid with inflow exceeding the outflow of capital. While the new Five-Year Plan [from 2011 to 2015] is expected to be positive to the credit market, the emphasis will be more on the quality rather than pure quantity of economic growth.

What should treasurers do today to better prepare their companies for growth in China?

Treasurers should develop a renminbi and foreign currency cash pool inside China to efficiently centralize the control of cash. In so doing, there is a need to rationalize bank relations. The currency mismatch between revenue and expense and that between asset and liability should be managed properly in light of the continued appreciation of the renminbi. To improve financing flexibility, treasurers should develop a renminbi corporate bond programme both offshore in Hong Kong and onshore in China.

How is the global economic recovery changing the outlook of corporates in terms of managing their working capital and liquidity position?

The additional round of quantitative easing in the US suggests that the recovery will take time. The high fiscal borrowing in the US and Europe may crowd out the bond market. Treasurers have larger cash balances as there is no urgency in capital expenditure in a recession and the desire to build a buffer against liquidity risk.
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How active should treasurers be in hedging risk?

The liberalization of domestic interest rates in China and inflation expectations will increase refinancing risks for treasurers. The future development of the renminbi corporate bond market is important. In 2010, foreign companies have been permitted for the first time to issue offshore renminbi corporate bond in Hong Kong. In 2007, the China Securities Regulatory Commission began to approve domestic corporate bond issuance.

We wish CSRC can start allowing foreign companies to issue bond as well next year. The long-term trend of the renminbi strengthening is difficult to hedge. The recent liberalization of trade finance settlement with renminbi may help exporters to bill and receive payment in renminbi to offset their cost base in the same currency.

What changes and enhancements are treasurers making in their regional and global treasury operations?

There is increasing use by treasurers of a treasury management system to centralize the control of cash and risk management. Treasurers are taking steps to realign their bank relations in light of the impact of the financial crisis on the banking system.

What’s the appetite among Chinese treasurers for outsourcing more functions and processes?

The first challenge is to centralize the cash management responsibility to the central treasury operations before outsourcing can be seriously considered. Such treasury transformation requires serious management commitment and expertise to be successful. The introduction of the Basic Standard for Enterprise Internal Control (aka China-SOX) by the Ministry of Finance will be a catalyst for the change in mindset of centralizing operations to minimize treasury risks.

The treasurers want to have the process and system to efficiently centralize their cash either regionally or globally to reduce unnecessary borrowing cost and control unmatched currency exposure to the minimum. Second, they want to achieve an efficient mix of in-house treasury processes which they need to control and those which banks or vendors can perform better due to scale and technology. Third, treasurers want a seamless connectivity between their ERP and TMS as well as that between their in-house system and the banking system.

This was published in the December 2010 issue of The Asset

Pushing to the clouds

It has become increasingly difficult for companies to cold-shoulder buzzwords in enterprise computing. ‘Cloud computing’, ‘virtualization’ and ‘standardization’ are crowding into the vocabulary of senior executives, be they in an organization’s treasury, data manage­- ment, human resources or logistics department.

The ultimate goal is to apply those technologies that serve the corporate bottom line, because this is an age where – as one executive puts it – the ability to leverage cost-cutting technologies defines the most competitive companies.

More and more enterprises are keen on taking advantage of new technologies that allow them to capture opportunities in a business environment where the outlook for growth has improved, according to Natalie Wan. This has led to more consultancy-led and business transformation projects proliferating around the region, in particular for cloud-related initiatives, which is the reason why the senior research manager of IDC’s Asia-Pacific services research group expects the IT services market in the Asia-Pacific ex Japan to continue to do well after the strong recovery in 2010. She forecasts a 9.4% year-on-year growth for the market in 2011.

A fair number of larger corporates around the region are oozing cash, like chocolate from Willy Wonka’s factory, making them prime candidates for investments in enhanced IT capabilities and platforms. Yet, the heightened level of corporate board scrutiny and worries about the possibility of a sudden turn for the worse in the economic environment necessitate a degree of prudence in spending the cash which leads the corporates to ex­plore the options provided by technology outsourcing which, in turn, has translated into a strong growth momentum for various types of IT services in the region.

Andrew Sampson says the cloud computing buzz has certainly caught on among corporates and financial institutions in the region in a bid to cut IT costs and respond to the more dynamic business environment. Under a cloud computing environment, the general manager for Hitachi Data System for Hong Kong and Macau explains, applications and services are not tethered to specific hardware components and processing is handled across a distributed, globally accessible network of resources, which are dispensed on demand, as a service.

As IT budgets continue to be stretched, cloud computing is enabling CIOs to do more with virtualization, standardization and other fundamental features of cloud computing that lower the cost of IT, simplify IT service management and accelerate service delivery. In doing so, CIOs can leverage available infrastructure more effectively to support the business goals of their company. By lessening the drag on data centre resources, cloud computing is enabling IT to hone in on real value creation, namely innovation.

Sending them up to the clouds

According to Sampson, the goal of a technology provider such as HDS is helping enterprises to better manage the storage of critical data in a way that will make it easier for them to take advantage of the cloud computing environment. When asked about the rationale of taking a bevy of journalists and clients on a helicopter ride to offer them a dramatic view of the towering Hong Kong cityscape, Sampson offers: “We are trying to send them to the clouds.”

His group launched an enterprise data storage platform in October 2010 that was a vast improvement from the one launched back in 2007. “We are in a world of data and information and the volume of data that enterprises have to cope with has been growing rapidly. Hospitals, for instance, create magnetic resonance imaging (MRI) scans and X-rays, most of them in three dimensions (3D), which patients may want to keep for a long time. Corporates too need to find ways to keep such records for a long time. In the financial services industry, banks are not allowed to delete data and may be required to keep records of their transactions for years.”

The whole social networking phenomenon has led to more data being created and stored. This has prompted companies such as Hitachi to respond with new products that can handle growth in data storage requirements and make the process more cost-effective, Sampson notes.

In Hong Kong, the group counts among its multinational customers distribution companies and manufacturers in almost any imaginable industry, including banks with large regional data centres in Hong Kong. Such large companies have to continually increase their storage capacity. Local Hong Kong companies too make up a major client segment and while their requirements are of a smaller magnitude, they still have to deal with a lot of the complexity. Smaller companies spend more time dealing with performance issues.

Sampson admits that technology glitches can cause a great many problems. “If a company’s e-mail system is not working, employees become frustrated. In quite a number of companies, once the e-mail system fails, everybody stops working to chat and idle away their time, wandering about the office. Not only does productivity come down but the company faces legal issues as well when customers are not served.” This explains, he points out, why Hitachi aims to provide every corporate with a high-performance platform where data are amply protected and secured.

Sampson says the new platform enables corporates to enhance performance by as much 30% to 40% and results in a 30% to 40% reduction in both power and floor space requirements. “There are plenty of corporate customers who spend more on power to run their date centres than they do on actual service or storage. Not only do they pay for electricity to power the hardware, they need air-conditioners to cool the computers too. More often than not, they end up paying more for power than for storage and service.”

The new storage platform introduced in the region in October is the industry’s first 3D scaling platform, according to Sampson, allowing organizations to become more efficient operationally and cost-wise in virtualized data centres.

Dynamic data centres

Hitachi virtual storage platform (VSP) helps transform data centres “into dynamic information centres where access to blocks, files and content is seamless and resides in a fluid and virtualized environment”, as Sampson puts it.

He argues that the data migration capabilities of the platform greatly reduce outage windows. The 3D scaling – scaling up in performance, scaling out in capacity and scaling deep with external storage connectivity – delivers extreme performance and capacity for robust disaster recovery and high availability systems.

Sampson believes there is no doubt that today’s data centres are reaching an inflection point, evolving into something that is more agile, more scalable and more efficient, with storage vendors delivering on the critical requirements. “Enterprises are looking to transform their data centres into an infrastructure that meets the demanding needs of today’s virtualized environment.”

Wan of IDC holds that the growth in demand for IT services in the region will be largely driven by outsourcing and project-oriented services, as well as an uptake of cloud services. The explosion in outsourcing of a large proportion of corporates’ technology needs has been motivated by a search for alternatives to traditional outsourcing models, triggered by the availability of IT-as-a-service and pay-as-you-go models.

This has resulted in increasing interest in hosted application management as a transition to a public cloud, along with data centre consolidation and virtualization projects, according to Wan. Server, storage and desktop virtualization, along with transition to next-generation data centres, have continued to fuel the growth of network consulting and integration services.

Business analytic solutions are growing fast as more enterprises are demanding predictive capabilities to capitalize on the value of information and enhance competitiveness and time-to-market. IDC analysts say the transformation of IT infrastructure, modernizing applications, as well as streamlining of business processes, are driving enterprises to increase their investments in IT.

This is why initiatives remain to reduce pressure from demand for capital expenditure. IDC believes such initiatives will continue to fuel innovation in outsourcing services over the next 12 months, as governance and IT service management take centre stage in the value proposition for outsourcing services.

This was published in the December 2010 issue of The Asset

Islamic finance pushes for liquidity

Conventional financial institutions find it hard to manage liquidity in volatile times, especially when their confidence to lend to each other is at a low end. During the global financial crisis two years ago, the liquidity contraction in certain structured products and interbank markets led to funding strains for banks and forced central banks to intervene and inject the needed liquidity into markets.

Since they were generally more liquid than their conventional counterparts, a number of Islamic financial institutions were spared much grief during the global liquidity crunch. But the liquidity seizure did not spare Islamic finance and impaired the ability of a few high-profile corporates and Islamic financial institutions to meet their obligations. Several of these were forced to scramble for more expensive liquidity.

The crisis served as a wake-up call for Islamic finance – in the same way it was an eye-opener for the conventional finance industry – and helped to highlight the importance of liquidity to the banking sector.

Overcoming constraints

The case of Dubai World which had issued sukuk to raise equity for its ambitious and often outlandish property project in Dubai is one telling example. If a global financial crunch happens again, there is no telling how tough it would be for corporates and financial institutions. If liquidity is considered to be the ability to fund increases in assets and meet obligations as they come due, then the implied assumption is that such obligations will be met at a reasonable cost. For this reason, liquidity management is an everyday reality that Islamic financial institutions contend with.

In view of the dearth of Shariah-compliant instruments where available liquid assets can be parked to generate stronger returns, it is arguably tougher for Islamic financial institutions to manage liquidity than for conventional banks.

In addition, there is often a maturity mismatch in terms of their assets and liabilities: they have locked most of the funds in long-term investments such as sukuk, project finance and real estate, while most of their liabilities are of a short-term nature, because most of their funding comes from short-term deposits.

Islamic finance experts are working to address these types of constraints. Shariah’s prohibition of riba, the lending of money at interest means that the scope for liquidity management has long been limited. International products in the money markets may be off limits to Islamic banks since those instruments rely on the payment or receipt of interest rates. It has not helped that only a few countries have active interbank markets in Islamic instruments. Malaysia is one exception and it boasts an active interbank market for Islamic negotiable instruments of deposits, negotiable Islamic debt certificates as well as mudaraba and wakala interbank placements.

Islamic bankers acknowledge that the dearth of Shariah-compliant short-term liquidity management instruments is a challenge for Islamic financial institutions and that they hope to see the entry of more liquidity management products in the market. This is the reason why the creation of a corporation set up by central banks and financial institutions in the Islamic world to help Islamic banks and other asset managers better manage liquidity has been described by bankers and ministers as “a major breakthrough” in the history of Islamic finance.

Filling a gap

The various players (including Bank Negara Malaysia) signed the articles of agreement setting up the corporation on October 25, during the Global Islamic Finance Forum (GIFF) conference, which attracted over 1,500 delegates to Kuala Lumpur. The following day Malaysia chaired the first board meeting of the International Islamic Liquidity Manage­ment Corporation (IILM), set up by central banks and financial institutions in the Islamic world to help Islamic banks and other asset managers better manage liquidity. Bank Negara Malaysia governor, Tan Sri Zeti Akhtar Aziz, says the entity will enable effective liquidity management for both Islamic financial institutions and managers of Islamic portfolios.

The goal of the corporation, according to Zeti, is to bring together regulators and key banking participants so they can establish a mechanism that will help reduce risk for a slew of Islamic institutions, especially during volatile periods. Earlier proposals have urged for the widespread adoption of Islamic repo agreements to ensure sufficient liquidity when institutions need it.

As the global financial crisis two years ago demonstrated, Islamic finance is not insulated from problems facing conventional banks.

While Islamic banks have been somewhat resilient to the global financial crisis, the supply shortage of Islamic instruments has nevertheless affected the effective management of liquidity within Islamic banks. KFH Research believes that IILM will fill this gap by providing the Islamic markets with new and innovative products that will allow Islamic financial institutions to better manage liquidity and risk.

Bankers say IILM could help asset managers better manage their portfolios with a cross-border flavour. Several stock exchanges already list Islamic funds, including ETFs, on their board. During the conference, Shariah scholars and other experts urged the industry to focus less on real estate and focus more on infrastructural development to enhance the development of the industry.

The evolution of the Islamic finance industry continues apace with more countries expected to issue sukuk in the near future. Participants at the Islamic conference say Thailand, Korea and even Australia could issue sovereign sukuk.

Dheerasak Suwannayos, president of the state-run Islamic Bank of Thailand, tells The Asset that the Thai sovereign sukuk can tentatively reach the market in June next year with the guidelines from the finance ministry expected to be issued in the fourth quarter this year.

Baljeet Kaur Grewal, managing director and vice-chairman of Kuwait Finance House and Research, told delegates on October 25, the first day of the conference, that global sukuk issuance could reach US$30 billion this year compared to US$24.7 billion in 2009, on the back of the recovery in global economic activity.

Clamouring for greater coordination

Francis Yeoh, managing director of YTL Corporation, says Islamic finance provides a golden opportunity for countries in the region such as Malaysia and Indonesia to enhance their prospects for growth by investing in each other’s infrastructure.

KFH Research says a number of jurisdictions have already come up with their own liquidity management tools, but industry players have clamoured for a more coordinated approach. This is required if the industry is to develop further and remain competitive.

In this regard, adds the research house, IILM has a concrete collaboration commitment by 12 regulatory authorities to establish a mechanism for more efficient management of liquidity across borders. The proposed short-term papers will be structured in such a way that they are easily accepted by investors and therefore intensely traded. “These efforts will serve to contribute towards the continued resilience of the global Islamic financial system.” The establishment of IILM is expected to enable Islamic banks and asset managers to be better equipped to face any liquidity crisis and thus support the systemic development of the Islamic finance industry.

It had been noticed that industry participants use a limited number of products to assist with management of short-term liquidity.

Baljeet says the IILM’s new products, due to be launched early next year, will be designed to directly assist asset managers in their task to maintain their institutions’ balance sheets and provide avenues to invest excess liquidity in short-term Shariah-compliant instruments.

The Islamic financial institutions will therefore be able to reduce liquidity risk by better matching their short-term liabilities with short-term assets. “With the development of Islamic finance spreading throughout the world and into non-Muslim jurisdictions, the need for liquidity management tools has deepened,” according to Baljeet.

She explains that in a conventional setting, institutions offering Islamic financial services are faced with a much greater challenge. For example, there are no liquid assets which Islamic banks in the UK can hold because there is no basis for the placement of short-term assets with the Bank of England on a Shariah-compliant basis. Without an efficient inter-bank market and the support from central banks, market forces have driven Islamic banks towards an increasingly sophisticated replication of conventional banking techniques. There is obviously a trade-off between efficiency and distinctiveness of Islamic finance, asserts Baljeet. Given the conceptual preference for profit and loss or risk sharing, much more fresh thinking and radical innovations are needed in order to engineer efficient instruments for participatory financing.

More short-term push

Islamic institutions today are heavily dependent on a small number of liquidity management instruments. Among the most commonly used is commodity murabaha with a tawarruq structure which acts as an inter-bank lending mechanism similar to the conventional lending arrangements. Such structures have faced troubles on a global scale with not all jurisdictions fully subscribing to the products. Baljeet feels that in order to develop cross-border liquidity it is important to get the structure right. One of the major challenges is to identify suitable assets that can be the basis for the underlying transactions and that are tradeable on a cross-border basis with full recourse to the law of the land.

The push towards more short-term instruments is merely one part of the initiative to enhance liquidity management. As the Bank of International Settlement (BIS) writes in a report on liquidity management at conventional banks, global financial market developments have transformed the nature of liquidity risks in recent years and the challenges facing financial institutions have grown in complexity.

It cites, among others, how the funding needs of banks have shifted towards greater reliance on the capital market, which is a more volatile source of funding than traditional retail deposits.

It notes too that the complexity of financial instruments has increased and that this had led to heightened demand for collateral and additional pressure on prospective liquidity from margin calls.

The increased cross-border business means that events in one market can quickly affect another, BIS notes. More banks face greater challenges in their intra-day liquidity management in relation to both their own activities and the activities of their customers. According to BIS, such challenges have been compounded by recent changes in the design of payment and settlement systems, which have become increasingly real-time in nature.

This article was published in the DEcember 2010 issue of The Asset magazine
The Asset website is at http://www.theasset.com

Capital dilemma

The region is no stranger to the consequences of an asset bubble. But will it have the political will to bite the bullet and impose capital controls that staunch the flow of easy money into its capital and property markets?

The economic success of the Asia-Pacific, its vibrant outlook and resilience have been key factors in attracting large flows of capital from the West and in fuelling optimism across the region. But regulators, including central bankers, have grown concerned that the US Federal Reserve’s policy of quantitative easing will result in more US dollars circulating outside the US in search of assets with the potential of providing a positive yield. When that wall of liquidity finds its way to Asia through investments in stocks, bonds and property, it could sow the seeds of a major asset bubble.

Capital controls become an option


McLaughlin: Positive about Asia's medium-term prospects
The region is familiar with the consequences of asset bubbles. In view of the amounts of money in circulation around the world, Andrew McLaughlin, the chief economist at the Royal Bank of Scotland (RBS), warns against countries naively relying on money which they know is hot. “A failure to address asset bubbles,” he explains, “will have damaging consequences that could severely affect the medium- to long-term prospects of regional economies.” The level of vulnerability differs.

“Some countries that are receiving the largest amounts may well suffer the most,” notes McLaughlin, “as soon as such inflows are held back and capital starts fleeing to other shores.” Korea is one such country that is extremely leveraged and too reliant on foreign capital. This has prompted the Korean government to pursue policies aimed at reducing leverage. The Philippines too has reported experiencing at least US$1 billion of inflows monthly in recent months. McLaughlin readily acknowledges that monetary authorities in the region still enjoy much leeway in monetary sterilization and other measures that mitigate the impact of hot money flows. In view of the magnitude of global liquidity flows into Asia, imposing capital controls has become a real option.

Erik Lueth, the senior regional economist for RBS, seconds this view. “Even the International Monetary Fund has moderated its hard-line stance against capital controls in the aftermath of the global financial crisis,” Lueth observes. “Its economic orthodoxy eased somewhat and Asia’s experience in the late 1990s was particularly instructive.” Lueth is referring to the Asian financial crisis of 1997-1998, when Malaysia and Korea, two of the countries that were most affected, fended off speculative attacks on their currency and stockmarkets by im­posing capital controls and as a result were among the first to recover from the crisis and to begin posting strong growth.

Not without risk

HSBC economists Frederic Neumann and Kim Song-yi argue that hampering capital flows has turned into an attractive option for policy-makers in the region. They point out in a report that capital controls that had been relaxed in recent years in much of the region – with the notable exception of China – are being re-evaluated. In recent months, Thailand, Korea, Taiwan, and Indonesia, have tinkered with various regulations and guidelines for foreign investors to stem inflows.


Neumann: Re-evaluating capital controls
“While these do not amount to full-blown capital controls, such policies are clearly aimed at slowing inflows,” Neumann notes. “More regulations are forthcoming, if only because without some form of capital control measures, it is hard to see a clear way out of Asia’s dilemma of surging currencies and asset bubbles. Raising the cost of money to stifle domestic demand will not do, because the higher rates would attract more inflows from outside, especially if capital controls have been relaxed.”

The prime motivation for capital controls is to discourage speculative activity and prevent excessive currency appreciation, notes the HSBC report. The most common measure seen across different regions is the imposition of taxes and investment limits.

It is worth noting, Neumann says, that capital control measures may relate to the liberalization of outflows. In order to ease upward pressures on the domestic currency, some countries choose to encourage outflows instead of curbing inflows, especially foreign direct investment inflows that could fuel economic growth and development. “Over the years, in a number of Asian economies, including Korea, the Philippines, and Thailand, the authorities have sought to offset strong inflows with greater outflows of local investor capital,” Neumann points out. “While this makes sense, on balance it is questionable whether capital outflow liberalization in itself is enough.” Neumann feels that the potential pool of investment capital awash across borders is infinitely greater for inflows than outflows.

Unintended side-effects

Still, even capital control proponents warn that imposing stringent capital controls can have unintended consequences that could dissuade monetary authorities from pursuing them. In 2006, for example, Thailand’s measures had a harsher-than-intended impact, while Brazil’s tax on inflows, at least initially, left markets entirely unimpressed.

Second, regulatory leakage may render these measures ineffective. For example, imposing taxes on certain kinds of inflows could redirect flows to other avenues, leaving the aggregate amount of capital pouring in unaffected. In fact, even economies with tight capital controls have been unable to stop the inflow of black money, as investors – or, perhaps more correctly, speculators – diligently drill holes into the regulatory wall.

Unlike rate hikes or even a managed exchange rate appreciation, Neumann notes, the impact of capital controls is hard to calibrate and therefore policy-makers have had little experience with such measures, and could easily overshoot or undershoot their goal of curbing excessive inflows.

Emerging bright spot

While the strict measures that Malaysia took in 1998 – effectively halting the ringgit convertibility – immediately come to mind when mentioning capital controls, McLaughlin points out that different ways exist in which capital controls can be imposed. China, for instance, has imposed tougher reserve ratio requirements for its banks. “By increasing the reserve requirements, the Chinese government raised the cost of the movement of capital and was able to keep the pricing mechanism in place. “I don’t think that some measure of capital control will undermine the efficacy of the market.”


Leuth: Even the IMF has moderated its stance
Lueth says the strengthening of the emerging market economies will continue. In the next 10 years, he opines, emerging markets are the place where investors need to put their money. McLaughlin too is positive about Asia’s medium-term prospects – in contrast to the uncertainty in the developed world. “The only exceptionally bright spot at present seems to be Asia and this explains why the region is feeling it is enjoying an autonomous growth engine. For the first time in a global cycle, people feel that Asia is not simply a play geared towards the US consumer.”

Yet, despite the malaise gripping the US economy, McLaughlin sees the US corporate sector as particularly robust. “The corporate sector, with the exception of real estate companies, has been remarkably well-behaved and corporate balance sheets show a fair number of them are enjoying huge financial surpluses. When the US corporate sector saw how bad the outlook was for the global economy – in light of the failure of demand to pick up – it was the first one to bite the bullet and pursue aggressive cost-cutting adjustments and clearing of inventory.”

This was filed in October but only published in the December 2010 issue of The Asset
The Asset website is at http://www.theasset.com

A positive counterweight

World finance is being transformed at an unprecedented pace. Rules and standards that were once de rigueur are being re-jigged with a view to avoiding the abuses that led to the global financial crisis. Conventional banking is eschewing riskier practices in a bid to restore confidence in banking practices and, in a way, has made Islamic finance as a platform for ethical banking more alluring. This may explain the amount of debate generated around the question whether Islamic finance can become a creative balancing force, a positive counterweight in global finance to conventional finance.

The value of global Shariah-compliant assets is estimated to be US$1 trillion. Forecasts hold out the possibility of a doubling in the next three to five years, according to Zeti Akhtar Aziz, governor of Bank Negara Malaysia.

Prospects seem brightest in the Middle East, Malaysia and Indonesia. Even non-Islamic jurisdictions, such as Hong Kong and Singapore, are looking to make their mark, especially on the wholesale side of the business. The number of purely Islamic banks is growing in Malaysia, Indonesia and the Middle East but a fair share of these opt to operate Islamic windows side by side with conventional banking operations – often using the same branches and banking platform – so as to save on operating costs.

Sheer demographics work in favour of Islamic finance. As of mid 2010, an estimated 1.57 billion Muslims – representing around 22% of humanity – live predominantly in Indonesia, Pakistan, Bangladesh, India, Egypt, Nigeria, Iran and Turkey. The world’s second largest religion is growing at 2.9% per year, faster than the 2.3% rate at which the global population grows. In other words, Islam is attracting a progressively larger percentage of humanity.

As the number of Muslims increases worldwide and the business expands in scale, the banks will likely grow more confident about setting up separate and unique platforms, catering to Islamic customers. In terms of funds, Saudi Arabia with a population of over 25 million is considered the largest player in the global Islamic finance market, even if its industry faces traditional bottlenecks, in addition to a scarcity of human capital and an underdeveloped market awareness among Muslims themselves.

Conducive regulations
Islamic finance does not only target the Muslim faithful. Banks in Malaysia report that a fair proportion of their customers are ethnic Chinese who have realized the value of business based on Islamic precepts, where risks and returns are shared rather than concentrated mostly on one side of the relationship. Only a handful of jurisdictions – Iran, Malaysia, Bahrain and Saudi Arabia – have so far been able to provide the conducive and robust regulatory framework required for the growth of Islamic finance. There is the recognition that it may take time before governments in other countries succeed in doing so.

Malaysia has been one of the most successful in this regard. Granted, it took a great deal of persuasive power by the Malaysian central bank before local players started buying into the idea of undertaking full scale Islamic banking and finance activity, and there is still much work to be done.

The development of the required legal infrastructure to facilitate Islamic finance is continuing, notes Bank Negara Malaysia deputy governor Dato’ Muhammad bin Ibrahim. He says it is part of an ongoing and dynamic process where they are constantly on the look-out to remove legal impediments to Islamic finance. “What lies ahead is to harmonize existing laws such that they accommodate and facilitate Islamic finance in the most legally efficient way possible.” These laws, he explains, are not confined to those under the financial services act, but to all Malaysian laws.

“As the future of Islamic finance depends on its agility and innovativeness in developing new products, our laws have to be facilitative and contemporary. Countries that intend to promote Islamic finance must have laws that are clear and easily enforceable. In this respect, having common laws, or a reference point for laws on Islamic finance, would serve to benefit the industry worldwide.”

Upholding Islamic financial contracts
One major issue for Islamic finance is whether it will be able to move to the next stage of its development and develop products that address the needs of its customers. The industry has, for the most part, been wary of changes that are perceived to diverge from the strict interpretation of the teachings of the Koran. The industry has witnessed a number of legal disputes involving Islamic financial transactions brought to Common Law courts for settlement.

As Muhammad highlighted in a speech at a recent Islamic finance conference, these recent cases have highlighted the hesitancy on the part of the Common Law judges to deliberate on issues concerning Shariah principles in Islamic finance transactions. “This is quite understandable given the lack of expertise on the matter. While evidence on Shariah matters can be admitted from subject matter experts, such evidence or advice is not binding.”

Muhammad believes that this was in evident contrast to the scenario in Malaysia where a dedicated High Court for Islamic finance related cases operates. “The judges refer to the Shariah Advisory Council (SAC) for questions or rulings relating to the Shariah and these rulings are binding. Malaysian courts, therefore, are well equipped to uphold the sanctity of the Islamic financial contracts as they have the avenue to make references. They have the capability to preside over such cases and give firm, consistent decisions with the backing of SAC rulings.”

As part of their collaborative effort to expand human capital development initiatives, Muhammad notes that measures are being implemented to ensure that players within the industry (including judges and lawyers) are trained in Islamic finance. “With the existence of a dedicated court, competent human capital and consistent legal precedents, our courts and arbitration centre are well qualified to serve as a platform for adjudication and dispute settlement.”

While the Islamic financial system, in Zeti Akhtar Aziz’s words, “does not exist in isolation and will continue to develop as an integral part of the global financial system”, it is equally not as vulnerable to the shocks that confront the real economy and “has weathered the global financial crisis well”, thus helping to shape a more mature view of the industry. Bankers says the recent global financial crisis showed that the industry’s crucible of strength lies in the quality of its assets. Unlike a slew of conventional banks, most Islamic banks had avoided the mistakes of investing in low-quality assets that suffered from a severe lack of transparency and ultimately lack of liquidity.

The road ahead
As advocates are careful to point out, this does not mean that the industry has yet achieved a high degree of transparency where it can afford to sit back and relax. In fact, a heightened vigilance is needed. This explains the steady stream of reminders from regulators of the need among industry players to tweak practices to address the lack of transparency and weak corporate governance. The experts are of the view that the industry needs more knowledgeable regulators and tougher regulations. In the Middle East, for instance, the industry should be moving to introduce greater transparency to profit-sharing investment accounts. Savers in these accounts tend to be less aggressive than shareholders, but ought to be better aware of what is happening.

Regulators have stressed that it does not suffice to take the model of conventional finance and apply Shariah rules. The process is more complex than that. The industry has to be proactive in launching sophisticated instruments that will provide it with enough depth of liquidity. At the same time, it matters a great deal how these accounts are structured. As one Bahrain central banker warned, there is always the danger that if one gets too close to conventional financial bonds, then you are no longer Shariah-compliant.

“Just as the health warnings on investment products constantly remind us, past performance is not necessarily a guide for the future,” Rasheed M Al Maraj, governor at the central bank of Bahrain, reminded a gathering of senior bankers and regulators.

“The industry should not extrapolate growth trends of the last five or ten years and use this as a guide for the future. The industry will only realize the predicted growth trends if it can properly address some fundamental issues, central to which are the business models of Islamic financial institutions.”


The Asset website is at http://www.theasset.com

China's wealthy gets pampered even more

How far China’s banks have reconfigured themselves after more than a decade of banking reforms gained greater clarity in September when Agricultural Bank of China (ABC) announced it had opened a private banking head office in Shanghai. The office opened auspiciously on September 29. Its bid to gain market share in a field where sophisticated financial know-how is required has been viewed by some of its more sympathetic supporters as a crucial step to a genuine transformation of the ethics and values animating the bank.

The idea that a bank originally designed to cater to peasants and farmers is gunning to serve the rich is no less than a major break with the past, no matter at what angle and through which prism you view it. And of course, some may argue that pampering to the wealthy may not be such a good idea in view of the widening inequality in the country.

ABC explains that the private banking initiative has been part of its plans to diversify the business operations after going public in July. The private banking head office aims to attract well-off individuals in 12 major cities across the country.

China is mostly uncharted territory for Western private bankers and is a tough nut to crack in view of the wall of regulations facing outsiders. Local banks, mainly the so-called Big Four – ICBC, Bank of China, Bank of Com­munications and China Construction Bank – continue to hold the competitive advantage. These banks have been successful in cornering sizeable chunks of the nascent industry. All four are building their private banking franchise across the country, establishing plush and cushy banking centres that cater to China’s burgeoning population of millionaires.

The intensifying competition is evident in the massive billboards across China’s urban space, something unimaginable 20 years ago, when banks, grounded in an ideology of classless egalitarianism, were shy to make a distinction between the services they provide to clients. Such reservations dissipated, in the wake of Deng Xiaoping’s surprise visit to the Shenzhen Special Economic Zone where he praised market forces and declared “To get rich is glorious”.

Private banking in China chiefly targets customers with financial assets of at least 8 million renminbi (US$1.1 million). There are an estimated 500,000 Chinese who own that much. Plenty of them have built their wealth without the help of private bankers. Considering the relative immature state of China’s financial markets, a fair number of the millionaires are adrift in a sea of misgivings, uncertain how to preserve their wealth for the next generation.

Products and consultaton

The first bank to appreciate the dire needs of China’s growing army of millionaires for professional advice was China Merchants Bank (CMB). The bank pioneered private banking when its established in 2007 what is now considered the first genuine private banking operation in the country, offering investment advice to wealthy clients. It has become one of the fastest growing private banking institutions in mainland China.


Chen: Hiring senior private bankers is quite difficult
The growth of private banking in China is creating a tight labour market for relationship managers and the shortage of skilled professionals could hamper the growth of private banking. Chen Kunde, director for wealth management at CMB, says formal private banking services were introduced only four years ago and as a result, there has not been time to develop a large pool of talent in China. “Hiring senior private bankers is quite difficult,” he laments.

This is the reason why in the initial stage of their private banking operation build-up, CMB relied mostly on its internal staff. This year, however, the bank embarked on a major recruitment drive to hire talent from outside. CMB is looking for candidates who are at least 35 years old and have over ten years’ experience in banking and investment, explains Chen. “We have actually raised our requirements for relationship managers. They do not have to have private banking experience but if they have been relationship managers in corporate banking, then they should do well in our bank.”

CMB’s commercial banking focus makes it private banking franchise very much a branch-oriented operation, where most of the clients are entrepreneurs. Chen says their private banking centres in Beijing, Shanghai and Shenzhen have experienced significant improvements in the past three years. “We have been able to serve the customers and attract more assets under management (AUM).” Asked whether CMB’s private banking can be better characterized as product-driven or consultation-driven, Chen declares that both sides are important. “If we were only using products, we would not have an edge over the competition.”

CMB has been proactive in developing products and introducing innovation. “I think we are the most creative in this market. We were the first to launch the private equity (PE) fund and the wine trust investment. And we have made efforts to establish an industry standard in alternative investments, including the Private Fund over Trust platform.”

Chen believes there is tremendous opportunity for private banking in China but that foreign-funded banks cannot match domestic banks in the ability to establish close personal relationships with customers. “You have to take the cultural background into consideration.”

Foreign determination

Meanwhile, foreign banks are all waiting in the wings, hoping the regulators will soon allow them to operate unhampered across the country. If it takes a while before foreign banks constitute a threat to local banks, it won’t be for want of trying. One foreign bank that had set up a private banking franchise in China, closed it after three years.

There is no doubting the foreign banks’ determination to capture the offshore component of private banking. Earlier this year Swiss banking giant UBS AG said that it expected private-banking revenue from China to at least double yearly, in light of the swelling ranks of wealthy clients in China and the relaxed rules on the sale of investment products to mainland Chinese investors.

Citi Private Bank announced in April the appointment of Rudolf Hitsch as its global market manager for China to be responsible for its off-shore China private banking franchise. Fluent in Mandarin, Hitsch has gained admiration as an accomplished China-focussed banker. His appointment was considered a major coup for a bank considering the challenge of finding someone who both understood the Chinese market well and had gained the confidence of a slew of Chinese billionaires with whom he has worked in the past. Before Citi, Hitsch worked at Goldman Sachs running a team of bankers concentrating on developing and covering clients for Goldman’s wealth management business in China.

Most foreign-owned private banks that feel confident about their future direction in China have by now set up a representative office in Shanghai – or are planning to do so in the near future.

They are looking far on the horizon, particularly 2020 when Shanghai is to achieve the status of an international financial centre with the potential to rival the major wealth management centre in the region of the stature like Hong Kong and Singapore.

This is one reason that goaded EFG Bank, the private banking subsidiary of EFG International that is headquartered in Zurich and has an international network, to establish a Shanghai representative office. While the new office cannot undertake any wealth management business at present, it hopes to use the branch for market research in order to help it identify the particular needs of its rich people in the country. And how different the needs are of high net worth individuals (HNWIs) in China compared to their peers outside China!

Propensity for property

A survey done by Merrill Lynch/ CapGemini illustrates that Chinese HNWIs’ love affair with real estate is intense: allocations made to real estate in 2009 accounted for around 40% of their portfolio, ranking them the highest in Asia in 2009. This enthusiasm for real estate blossomed in 2008 and 2009 owing to the government economic stimuli programme that encouraged banks to ease lending rules. 2010 could be an altogether different story with government’s renewed determination to cool the property market.

Boutique private bank Pictet has warned that a real estate bubble is well under way. The bank points to a chief barometer of how inflated the property bubble has become – the ratio of average price to annual income. This ratio presently stands at an over 10-year high in China overall, and in excess of 17 years in Beijing and Shanghai. By comparison, property is regarded as expensive in Europe if the ratio climbs above 4 years.

The averages in Asian countries range between 5 and 7 years. The bank pointed out the absence of a property tax and flexible mortgage conditions have tended to encourage speculative investment in property. “As a result, a structural imbalance has developed between real demand – basically demand for entry-level housing – and the supply of property, often concentrated at the top end of the market which is highly profitable for property developers.

According to Pictet, the imbalance further fuels the upward pressure on property prices as households in the upper quartile are estimated to number over 50 million, eight times higher than property production. Furthermore, the price/income ratio in this particular segment, at 6.5 years, is one-third lower than the nationwide average. It is difficult to counterargue the Chinese appetite for solid property assets.
Powerful dynamics underpin the current property boom.

As the Merrill Lynch/CapGemini study points out, urbanization and rapid economic growth in the country is resulting in a significant shift of the population from rural to urban areas thus fuelling domestic demand. The survey establishes that wealthy Chinese investors have expressed a marked preference to put their wealth to work in equities rather than fixed income. China’s booming stock market has made billionaires of its entrepreneurs and that is likely to continue in the coming years.

Gold, jewelry and gems as well as art are starting to assume greater importance as tangible investments. India and China, for instance, account for more than a third of gold demand. China is now also the third largest fine art market in the world with a share of about 17% the world market.

A new era for structured products?

Two years after the global financial crisis that proved cataclysmic for investors, there are only few places in the region that banks describe as ‘happy places’ – markets where they can aggressively sell derivatives and structured products, especially to retail investors. Yet the commitment of some banks to structured products is unwavering.

In Hong Kong and Singapore, a heavy residue of suspicion and anger still lingers after numerous portfolios of high net worth individuals and institutional investors were virtually wiped out by derivative products that turned out to be toxic in the aftermath of the global financial crisis. The most significant exceptions in the region seem to be Australia, and a scattering of markets such as Korea, Malaysia and Japan where among high net worth individuals and institutions, the appetite for risk is coming back, albeit in a moderate fashion.

In view of their keen focus on managing assets and liabilities in a low interest rate environment, insurance companies have been cited by banks as the most active and most consistent in employing derivatives and structured solutions in order to manage risk and achieve yield targets. This is especially so in Korea, where a fair number of medium-sized insurance companies have outgunned some of the bulge-bracket insurance companies in using structured solutions in their portfolios. Bankers believe the former were less distracted, since they were not preparing for their IPOs.

Protecting the public

In June, Hong Kong’s Securities and Futures Commission completed a public consultation on new regulations on how structured products are to be sold to the public. Among other things, the proposed regulations require the mandatory return of cash paid for the investment, if investors decide within a certain period that a purchased product does not suit their needs or risk profile. In addition, banks selling structured products would have to report their financial strength on a regular basis, so as to enable regulators to ascertain whether such banks can stand as reliable counterparties for the products they offer.

“These days,” admits the head for global product distribution in one bank, “Hong Kong is a much less happy place for a majority of us. Near [investment] banks in Central [Hong Kong’s main business district], you still find protesters complaining of the losses they suffered two years ago from derivative instruments, including mini-bonds and accumulators. It is much different in Sydney.”

The public’s psychological and financial trauma proved less severe in Singapore, given that offending banks were ordered by the Singaporean government to promptly compensate investors when the crisis broke. In Taiwan, banks without an onshore presence have been banned from selling structured products into the market. “They put a stop to the practice where people with only their business cards boarded a plane to Taipei, sold products to investors and then left the country with the cash. When things went wrong, the investors and regulators had no one to run after.” At the height of the crisis, complaints were particularly rife against US banks that lacked a licence to operate on the island.

US$1 million a click

The majority of the leading banks in the derivatives and structured products industry managed to ride out 2009 with a respectable performance, in spite of the challenges facing the industry.

The mood was bright too in the first quarter of 2010 and turned cloudy in the second quarter over worries about the introduction of tougher regulations and the uncertainty that was creeping into markets as a result of the European sovereign debt problems.

Matthew Wong, managing director and London-based global head for retail platform distribution at RBS, recalls that the first flow products to come back into the markets after the problems in 2008 were share accumulators, instruments that in 2008 proved so toxic to investors that they shook the confidence in the private banking business. The contracts forced investors to accumulate shares at the peak of the bubble price at a time when the value of those shares were crumbling by as much as 80%. When worldwide equities markets recovered in 2009, investors who actively positioned into this type of flow product benefited handsomely.

Wong points out that the people who did accumulators in 2009 were vastly different from those heavily engaged in 2007. “Those in 2009 were strong, with a whole number of them funding at US$1 million a click.” When the Hong Kong market moved up significantly in September last year, most of the investors made a healthy profit. Wong notes that during that September month, most of the popular stocks for accumulators rebounded strongly, with the exception of PetroChina. The large hedge funds with high holding power managed to come back as well – and brought in more fire power. “Those are the reasons for the respectable performance of our flow business and private banking business last year,” explains Wong.

Wong says sellside institutions have to adjust to the reality of changed markets and regulatory conditions and should invest in systems to take advantage of the volume returning to the market once the new regimes are in place and a full global economic recovery takes hold. “In RBS, once we realized that the volume of the demand for share accumulators was rising again, we provided better service for the flow, introducing auto-pricing for the contracts.”

Considering that accumulator contracts are often generic and standardized, the trades can be automated easily, argues Wong. “Instead of they calling us or we calling them, clients can quote prices through an email instruction using a template which we provide.” Auto-pricing takes the data from a client’s email and then replies or confirms the price at once. At this juncture of market development in the region, opines Wong, derivative and structured product players ought to focus on ways to deliver products efficiently to clients rather than focussing too much on payoff innovation.

No real consensus


Pang: The most important thing is to bring back investor confidence
Henry Pang, head of derivatives and structured products in Asia ex Japan for BNP Paribas, partly faults the World Cup distraction in South Africa for the slowdown in trading activity in accumulators and other products during the second quarter of this year. He expects the rest of the summer to be quiet too, since most will be out for their holiday. In June, for example, Hang Seng Index futures turnovers were among the lowest recorded in recent years. The lack of interest, he asserts, stems from the lack of a sense of direction where the markets are heading. “The more people you talk to, the more diverse views you get.”

Typical discussions in recent weeks has been desultory at best, with the financial press focussing on the debate whether there will be hyperinflation or deflation, or whether the markets are in a bull or bear state. “There seems to be no real consensus.” Pang calls the situation “tricky” as it affects the willingness to participate in stockmarkets and thus dents the sales of equity-linked structured products.

The current uncertainty, Pang notes, is different from that of last year, when the concern was more about whether the market had gone down enough, and when the markets would recover. “There was general disbelief and a lot of people said it was nothing but a dead-cat bounce,” Pang recalls. “But back then, the momentum in the market was strong, with the ‘golden crosses’ in the moving averages indicating bullish signals.”

The market today lacks conviction, feels Pang, and investor opinions often depend on the reports they read or on the websites they happen to look at that day. The diverse views on market direction not only prevail in equities, but in currencies as well. There has even been active speculation about the stability of the Hong Kong dollar’s peg to the US dollar peg.

Volatility as an asset class

Nonetheless, Pang argues that it is in this kind of environment that investors can use derivatives as a powerful tool to achieve investment objectives. “When­ever there is uncertainty about the directions of the market, volatility becomes a good asset class to invest, and a good number of BNP Paribas client-investors take this angle.”

It has become obvious after the financial crisis of the past 18 months, believes Pang, that derivatives and structured products providers need to move on in terms of their expectations. “We are operating in a different era. We welcome changes that will lead to higher transparency and more information related to products for investor protection. We understand that as an industry we need to do more work in terms of product and design.” Once everyone has settled into the new regulatory routine, Pang is confident that the market will benefit the most and the industry will continue on its growth trajectory in the long run. “The most important thing is to bring back investor confidence.”

The result of the consultation process on the sale of structured products to retail investors in Hong Kong has just been published. The new regulations call for a cooling period to allow investors to think through whether the structures suit them, and a mandatory repurchase of products. On the part of the providers, such regulations will require additional work. Approving of the suitability aspect of the new regulations, Pang believes they will introduce a higher degree of transparency into the purchase. “The idea behind the mandatory repurchase is that after investing in the structured product, the investor can unwind a structured product over a prescribed period, subject to the investor taking responsibility for the market movement effect. That is a fair requirement.”

Share accumulators have not died

So far, notes Pang, 2010 has proven to be a year for flow business. In structured products there has been a gradual return to more medium-term products. There is significant appetite for plain-vanilla single-underlying products but other products will likely start to pick up as the year progresses. “We are still waiting for a large-scale return into correlation products. We believe that there is a cycle in the evolution of demand. If there is single underlying demand, then we are going to see demand for more vanilla products.” The interest rate environment is vastly different from 2003, while China is becoming an important asset class and so even in a relatively low activity environment, there is still demand for Chinese underlyings and for structured products linked to Chinese underlyings, according to Pang.

“Investors in this part of the world have become more sophisticated compared to six years ago, thanks to the electronic media,” Pang points out. “As far as the existence of alternative investments goes, they are switched on. The traditional equity investor in the region has ventured into the foreign exchange (FX) market and property. Of course, you therefore have competition coming from other asset classes, especially commodities such as gold. For the retail market, we have provided warrants on commodities and gold.”

Share accumulators have not died. “These are contracts that are here to stay,” Pang states, while cautioning investors to first fully understand the merits and the downsides involved, before making a move on them. “These are highly leveraged instruments – quite often about two times leverage built into the product. Investors should take the cash flow implications into account. It is often all about holding power and margin calls and one should be implementing a stop loss strategy at the time of the transaction.” The average trade size for accumulator contracts has become much lower than two years ago and a slew of players have grown conservative because of the leverage effect and so are generally less concentrated in their positions.

Committed to structured products


Garnier: The silo approach in selling products to clients is gone

More recently, accumulators in fixed income have proliferated too and there are more fancy variations because of the lower volatility, unlike in equities where there is less of a need to put in complex features because the volatility is already pretty high. “We merged the fixed income and equity derivatives structured products into one integrated platform in the middle of last year,” says Yann Garnier, head of sales, cross-asset solutions in the global markets division, Asia-Pacific, at Société Générale, “thus allowing the bank to provide a cross-asset platform where clients enjoy single access to any asset class on the product side as well as in the solution side.” The platform includes equities, commodities, FX, interest rates, credit, funds and hedge funds.

“The silo approach in selling products to clients is gone and the client does no longer talk to someone who may be biased towards a specific asset class,” Garnier explains. The solution offered to clients is based on a discussion of their needs. “Some of these companies find that the traditional interest rate products that they used to work with are not so interesting any more, in light of the current low interest rate regime and alternative products with the same type of duration,” explains Garnier. Since it has been two years since the financial crisis started, most of the valuation problems faced by institutions are behind them and the questions mostly revolve around recovery, according to Garnier who has noticed a marked return of appetite for risk among Asian institutions.

There has been no attrition of the resources at the structuring and derivatives platform at Société Générale, says Garnier. “We want to maintain the resources that we have and intend to continue hiring people in segments where we feel we need more coverage. For instance, during the crisis the group realized that it needed to enhance their investment in private banking in Hong Kong.” This explains the subsequent major recruitment drive. “Servicing private banks is taxing, because of their high demands. You have to be up to standard to become one of their preferred partners. It is about the depth and quality of service we provide.”

Islamic finance grows

Raja Teh is familiar with the multitude of Western misconceptions concerning Islam and Islamic finance and is keen to tackle these so the outside world can gain a more concrete understanding of the potential of the industry.


Too often the error arises from the ignorant presumption that Islamic ideas, beliefs and practices are cast in calcified stones, and that hard-lined Islamic zealots are too intractable and unyielding to the ideas that have spawned the modern world.

In fact, Islamic laws themselves are subject to varying interpretations by Shariah boards. There are those who take a hard-line stance in interpreting the teachings of the Prophet Mohammed and there are those who take a more liberal view.

Teh, who is the head of Islamic business at Bursa Malaysia and one of the moving forces behind the exchange’s move to develop a global Islamic hub, says the developments in the last thirty years belie the notion of an unchanging face for Islamic finance. “More changes are sweeping through the industry now that is itself rapidly entering the cusp of maturity,” she points out.

The problems faced by a slew of Western financial institutions and the shadows of doubt that surround Western corporate governance and regulations are now giving Islamic finance the necessary gravitas to challenge the dominance of those practices. Islamic finance will proceed at its own pace, Teh contends, and will not mindlessly bite into the esoteric structures and techniques that have weakened Western finance in recent years.

Steady and gingerly

The industry will continue to tread carefully, especially when introducing changes and new ways of doing things, and will not embrace innovation for innovation’s sake. “We are particularly careful that we hew closely to Shariah principles,” Teh stresses emphatically. “Innovation is fine but whatever changes and innovation must be in the ambit of validity.” This suggests no radical departure from how things were done in the past decades and Teh says it is inconceivable that things could move at the speed at which conventional bankers are used to doing things.

In the Islamic sphere, she points out, all practices and proposed innovations go through a vetting process and the final test of a product’s acceptability is sealed with the approval of a board of Shariah scholars. Outsider observers may think that such vetting runs the risk of constricting the imagination of the industry and stifling growth.

While recognizing that the ability to constantly innovate provides the essential alchemy and catalyst for Islamic finance to remain relevant in the complicated world of business, Teh – who used to be chief corporate officer and head of international business of Kuwait Finance House (Malaysia) – emphasizes how crucial the Shariah scholars are in view of their deeper understanding of the scripture and their talent for interpreting the rules to believers.

Teh says that when they introduced Bursa Suq Al-Sila’ last year, the commodity murabaha trading platform became the first Islamic commodity trading platform in the world. “Our hope is that it will reinvigorate the fledging Islamic markets, and may one day evolve into a thriving and powerful global Islamic exchange that attracts traders and investors across the globe.”

She is confident that her Islamic markets team has what it takes to build what could become a global hub for Islamic products. “We have been here in this industry the longest and based on our experience and skills we can make it work. By introducing the commodity murabaha trading platform, we ushered in what we feel can be our most significant gift to the world – if the world accepts it.”


Teh is optimistic about the future of Islamic finance and banking. “This is a young industry,” she tells The Asset visiting her at her Bursa Malaysia’s office in Kuala Lumpur. She is proud of what has been accomplished in Malaysia in terms of building Islamic finance. “I believe that we are the only one in the world with a parallel interbank Islamic money market alongside a conventional market.” She is pleased that the industry is moving in the right direction, with banks and other institutions placing greater focus on building their Islamic franchise.

And while a fair number of practices are already changing in response to the various realities facing the industry, she is well aware that a lot of things still need to be done. In the last 20 years, for instance, Islamic finance has seen the introduction of hybrid products such as exchangeables or convertibles. “These are old concepts in the conventional world,” she points out, “but still rather new in Islamic finance.” There has been a considerable change in attitude. For most of its past, the Islamic finance industry was reactive and slow to explore the possibilities presented by its own unique outlook and practices. “Too often, we were not looking at how things should move forward, with the industry reacting and taking decisive action only when the whole industry was already caught in a turmoil, wallowing deep in a problematic situation.”

Teh is clearly one of the shining lights to have emerged in Islamic finance in recent years. Her credentials are impeccable. She has over 18 years of banking experience focussed on investment banking and Islamic finance prior to joining Bursa Malaysia. She was the chief corporate officer and head of international business of Kuwait Finance House (Malaysia) where she was responsible for the bank’s regional expansion and establishment of its Singapore and Australia offices.

Prior to that, she was CEO of UIB Capital, which is a wholly-owned subsidiary of Unicorn Investment Bank in Bahrain. She served at RHB Sakura Merchant Bankers (now known as RHB Investment Bank) where she was responsible for the establishment of the investment banking division. Before that, she was with Commerce International Merchant Bank (now known as CIMB Investment Bank) for some nine years covering debt and equity origination, and equity sales.

Ironic prohibition

Teh would be the first to admit that Islamic finance was affected by the global financial crisis. “And how could we not be?” she asks, adding that the entire industry does not operate in a vacuum. “We are still much tied to the real world, so it was never correct to say that we would be fully shielded from the crisis. We operate as a part of the real economy.” Yet, the crisis is turning out to be a useful prelude to scaling even greater heights for the industry, according to Teh.

The crisis immediately made it clear that Malaysian Islamic institutions were less vulnerable to the contagion that had sapped the strength of major regional banks. “The industry was spared from the worst impact of the crisis, the value of their assets not having deteriorated as much as those of Western banks, much on account of the fact that Islamic banks were much less exposed to toxic financial instruments,” she explains.

The irony is that the prohibition against investing in derivatives used to be considered as one of the serious weaknesses faced by the industry – with rating agencies like Moody’s and Standard & Poor’s coming out with reports claiming that the inability of a large number of institutions to a use derivatives to structure aggressive hedging techniques rendered them less able to manage their risk. Now that prohibition has vindicated Islamic finance, as it shielded numerous Islamic institutions from monstrous losses when those instruments failed.

Still, a considerable number of Islamic institutions with significant exposure to property assets suffered considerably when their assets depreciated as a result of the crisis. “The speed at which prices corrected during the crisis was so sudden that hardly anybody who is anybody was unaffected, since most were significant investors of property across Asia. Nobody wanted to be left holding those investments and as prices plunged, substantial losses piled up.”

Malaysian fortitude

The evolving debt crisis in Dubai further worsened the situation as the possibility grew of a default by several corporates, most famously among them Nakheel Properties, the property arm of Dubai World. “People reacted adversely to the development,” says Teh, describing the subsequent backlash on other Islamic structures as nothing more than “a naïve reaction” to the developing crisis. She suggests that there was, in fact, little to worry about, considering that Islamic markets’ exposure to Nakheel was only US$5 billion out of Dubai’s US$80 billion outstanding debt.

Even Dubai’s overall debt position was relatively minuscule and nowhere near, for instance, the trillion dollar debts owed by Lehman when the investment bank collapsed in a heap. All the drama and the Doomsday scenarios that attended Dubai’s troubles confounded her since, in the perfect storm that ensued, throngs of investors shied from Islamic instruments and conveniently forgot that Nakheel was largely a credit issue and not an Islamic structuring issue. “Whether what was sold was an Islamic structure or a conventional structure, at the end of the day the debtor still has to pay.”

While Nakheel’s sukuk was a property-backed deal it became painfully obvious, according to Teh, that it couldn’t continue to build the fancy real estate developments it had been pursuing in the Gulf state and around the world, considering that the whole luxury residential market was collapsing under its feet. While investors questioned the Islamic provenance of Nakheel’s sukuk structure, the issue was really with investors who took the risk of investing in that sukuk. “The prospectus clearly stated there are risks with the investments.”

Teh says Islamic financial institutions in Malaysia proved resilient during the crisis given the fortitude they had developed ten years earlier. After what they went through ten years ago during the financial crisis they were ready for anything. “That crisis crystallized the realization for everyone that a debt is a debt and has to be paid back.”

What helped Malaysia even more was the robust regulatory framework in place. With hindsight, the Malaysian government demonstrated a focus and concentration in developing a strong and robust regulatory regime. “The government looked at basic and fundamental indicators, such as capital adequacy requirement, and this proved crucial,” explains Teh.

In Malaysia, banks are not allowed to invest in real estate and Islamic institutions engaged in financing real estate transactions mostly have a nuanced view regarding the different risks involved. In a musharaka partnership financing scheme, the capital cover for partnerships is treated differently because losses and profits are equitably shared. Other prescriptive measures include requiring sukuk sold to the public to be rated before they are marketed. “You simply cannot sell junk papers in the market,” Teh points out.

This is in sharp contrast to practices in countries of the Gulf Cooperation Council (GCC) where investors tend to be more yield-driven so rating becomes a secondary consideration. Before the bust, a lot of papers were issued in the GCC that were unrated, in fact most of the issuance did not carry any rating since that was not mandatory. And even if rated below investment grade, it could still be sold as long as you provided a decent yield.

Reaching global markets

“That’s a difficult thing to do in Asia. Even if you come up with a 20% return and it is not investment-grade, it is a challenge. In a sense, our market has moved. It is good and I guess it has reinforced our position as a Islamic finance hub in the region. Real estate proved to be the Achilles heel for so many financial institutions in the GCC, due to the fact that most of them had loaded exposure to the asset class, and a number of investment banks had more than 50% of their assets in real estate. The crisis forced a fire sale where they lost as much as 30% to 40% of the value of those assets.”

“We developed Islamic finance primarily to service our domestic market.” Teh says they are happy that other markets such as Singapore and Hong Kong are looking to developing their own Islamic finance expertise as well. “They are looking at Islamic products as an asset class that cannot be ignored. Since those two countries don’t have a large Muslim population they are opting top focus on the wholesale market just as London had done in recent years. We are encouraged by this, and do not feel threatened,” Teh tells The Asset, when asked if she is worried about the challenges posed by the two cities.

Last year, even US giant General Electric tapped into the general market and issued a sukuk. She considers this a major breakthrough, since that was the first US corporate to tap into the Islamic markets.

“We want more people to embrace Islamic finance. It is hard to call yourself an international financial centre if you are alone in this, so you get the global markets.”

This story appeared in the April 2010 edition of The Asset