The Malaysian Bond Market CHAPTER 5 N The Malaysian Bond Market

Learning Objectives Describe the Malaysian bond market. Describe the different types of bond issuers in the Malaysian bond market. Describe the different types of bond investors in the Malaysian bond market. Describe the different forms of debt securities. Explain the role of the Malaysian bond pricing agencies. Explain how bonds are rated. Explain the role of global bond agencies.

THE MALAYSIAN BOND MARKET The Malaysian Government started to issue bonds in the 1970s, mainly to raise funds for the country’s development projects. When the country grew, the dominance of the government as bond issuer shifted to the private sector. Instead of relying on banks and equity markets to source finance, private companies used the bond market as an alternative source of capital.

The Needs for Strong Bond Market Malaysia needs a strong domestic bond market for the following reasons: Investors demand large amount of finance for their manufacturing activities, infrastructure improvements and provision of services. The change in the economic structure from labour intensive to capital intensive industries demands long-term debt financing that cannot be met by the banking sector or equity market. Long-term institutional investors needs funds for portfolio diversification and asset liability management purposes.

WHO ARE THE ISSUERS? 1. Government of Malaysia Government issues marketable bonds to finance development expenditure. For development expenditure, the government issues interest-bearing long-term bonds in the domestic capital market.

WHO ARE THE ISSUERS? Government of Malaysia Bonds raised in the capital market bear fixed rate semi-annual coupon payments with repayment of principal upon maturity. Also issues long-term and short-term non-interest –bearing securities based on Islamic principles. These securities are known as Government Investment Issues (GII) and Malaysian Islamic Treasury Bill (MITB)

WHO ARE THE ISSUERS? 2. Bank Negara Malaysia Roles and responsibilities of BNM includes: the economic management, institution building and expansion of financial system. Acts as the banker and adviser to the government (role includes managing the liabilities of the government both in Malaysia and abroad, advises on loan programmes such as planning the government securities auction calendar, timing of loan and issuing of new types of securities) The central bank issues bonds to manage liquidity in both the conventional and Islamic financial markets. Bank Negara provides temporary advances to the government to cover any deficit in the budget revenue.

WHO ARE THE ISSUERS? 2. Bank Negara Malaysia Examples of securities issued by Bank Negara are: Bank Negara Monetary Notes Discounted or coupon bearing government securities with maturity periods of 91, 182 and 364days and one to three years. Issued to manage liquidity in both conventional and Islamic markets. Offered through competitive auction among principal dealers.

WHO ARE THE ISSUERS? Bank Negara Malaysia Sukuk BNM Issues Zero coupon bonds with maturities of one to two years. Based on Ijarah (sale-and-lease back concept) Merdeka Savings Bonds Savings vehicle targeted at retirees by offering a slightly higher return than the market rate and tax exempted. Based on Islamic banking concept of Bai’Al-Inah ((sale-and-lease back arrangement)

WHO ARE THE ISSUERS? 3. Quasi-government Institutions Khazanah Nasional Berhad - It is the investment holding arm of the Government of Malaysia. Khazanah’s main long-term objective is to promote economic growth and make strategic investments on behalf of the government which would contribute towards nation building. Pengurusan Danaharta Nasional Berhad - Public company wholly owned by the Malaysian government. Act as the national asset management company. Re-energize the Malaysian financial sector by buying non-performing loans (NPLs) from financial institutions and maximize their recovery value.

WHO ARE THE ISSUERS? Danamodal 3. Quasi-government Institutions Special purpose company incorporated by Bank Negara Malaysia Recapitalize and strengthen Malaysia’s banking institutions Promote stability in the local banking industry

WHO ARE THE ISSUERS? Cagamas Berhad The National Mortgage Corporation Leading securitization house Promote development of the private debt securities market Promotes secondary mortgage market in Malaysia Issues debt securities to finance the purchase of government servants’ housing loans Cagamas issues are: Cagamas Fixed Rate Bonds Cagamas Floating Rate Bonds Cagamas Notes Sanadat Mudharabah Cagamas (housing loan, finance/lease)

4. Multilateral Development Banks The World Bank Group MDBs grant financing for technical assistance, advisory services or project preparation Provide financial support and professional advice to the developing countries in terms of economic and social development activities. Interest rate is fixed over their stated maturity. MDBs borrow development funds from international capital markets and re-lend to the governments of developing countries in the form of long-term loans. The MDBs use money donated by governments of other countries to finance very long-term loans. The borrowing countries pay interest well below market interest rates.

BOND INVESTORS Employees Provident Fund Pension Funds Unit Trusts Insurance Companies Asset Management Companies Discount Houses Commercial Banks Islamic Banks Investment Banks Securities Companies Finance Companies Merchant Banks

DEBT SECURITIES PRODUCTS Fixed rate bond. Hybrid bonds. Floating rate notes. Variable rate notes. Medium-term note programmes. Commercial mortgage-backed securities. Asset-backed securities. Securitized products.

Types of Government Securities M’sian TB – short-term govt. securities M’sian Islamic TB – short-term govt secs. M’sian Govt. Secs – for long-term project financing Govt. Investment Issues (GII) – Long-term Islamic financing

Corporate Bonds Straight Bonds – often called “plain vanillas”, with fixed coupon rate and maturity period at the time of issue. Tend to carry high interest rate. Bonds with detachable warrants – options to purchase a number of shares at pre-set exercise price, within a specified time. Floaters – floating coupon rate. Zero-coupon bonds – sold at a discount and redeem at par on maturity. Asset-backed securities – backed by assets such as mortgages, loans, receivables, etc. E.g. mortgage bond requires the issuer to pledge certain real asset as security for the bonds. Convertible bonds – rights to convert the bonds into a specified number of issuers’ stocks, within a specified time and specified price.

Islamic Bonds Debt-based bonds – for sale and purchase of assets based on deferred payment. Asset-based bonds – for income–generating assets (leasing). Equity-based bonds – joint venture business (represent common ownership and entitle the holders shares in a specific assets). BNM – Sukuk Ijarah (sale and lease-back concept).

Islamic Bonds Merdeka-Saving Bonds – for retirees (age 56 and above) M’sian Islamic TB BN Monetary Notes

Bond Rating Agencies Investors and financial professionals look to one rating agency that is authoritative, objective and credible to assess if issuers will default in paying back their principal or deliver the promised periodic coupon payments. Investors are likely to seek the expertise of rating agencies that will analyze and provide rating scale on bonds issued by different issuers. They are independent from bond issuing companies. Focus on credit analysis of issuing companies to assess on the chance that a bond holder will not receive the scheduled interest payments or principal at maturity. Default risk is assessed according to the creditworthiness of bond issuers over the life of a bond.

Bond Rating Agencies Local RAM (Rating Agency Malaysia Berhad) established in 1990 MARC (M’sian Rating Corporation Berhad) established in 1996. International (Global independent rating agencies) Standard and Poor’s Moody’s