The US Federal Reserve will not raise interest rates, at least yet. Following the Fed’s announcement on Thursday, the dollar fell against many currencies (including MENASEA regional currencies that have been hammered as of late). To the extent that the Fed’s concern for Emerging Market turmoil allows it to remain on hold through the remainder of the year, it may provide breathing space for emerging markets that have felt the most severe crunch although oil exporters are not likely to benefit as much as the price of their primary exported commodity lost what gains it had picked up prior to the Fed’s announcement.
Malaysia corporate sukuk primary markets showing higher risk premiums but not distress
The Malaysian market is the most active in Asia and received attention in the Asian Development Bank’s September 2015 Bond Monitor relating to the observation that “despite headwinds from challenging developments in the global economy [the] region’s sukuk market managed to post modest growth in the first half of the year”. The headwinds for Malaysia have been mulitifaceted: wider emerging market uncertainty caused by the China slowdown, lower oil prices causing higher budget deficits, the imposition of higher goods and services taxes (GST), a political crisis around sovereign fund 1MDB.
But, despite this sukuk issuance held up and issuance of corporate sukuk in domestic MYR markets was not an exception through June when volumes were $789 million compared to a year earlier when they were $796 million (down less than 1%). There were some corporate sukuk issued in July but none since then, which has changed the YoY picture with YTD issuance dropped 18.8% over the same period last year but issuance will not tell the entire picture. As the Asian Development Bank notes, “Both Indonesia and Malaysia have a large foreign investor share in their bond markets and therefore are exposed to the shift in investor preferences away from emerging markets.”
So, rather than look solely at issuance volume which will be driven by company’s needs to refinance their existing offerings which will be more attractive when there is large foreign investor inflows (and less attractive when the flows reverse), it is better to look at the spreads for whatever issuance there is above the local currency benchmark since an emerging market with relatively open local currency markets (like Malaysia), will see the impact on new issuance following a withdrawal by non-Ringgit investors accentuated by the fall in the value of the Ringgit in increasing outflows.
What is useful to consider instead of issuance volumes and overall rates for Malaysia’s bonds and sukuk (including sovereign) is the risk premium that different corporate sukuk carry and how overall trends have shifted. This allows some disentangle of changing risk appetites that, while affected by external events, will be much less affected than flows because, as the data shows, the shift in global investor interest leads to dramatic shifts in issuance volumes (and emerging market currencies). What would be expected if the adverse events (China, oil, 1MDB, GST rises) were to spill over dramatically into credit markets (and specifically into the corporate market where sukuk represents 72.1% of total outstanding volumes), is a rising spreads of new issuance as investors reprice risk to account for a higher potential likelihood of slower growth ahead (and the defaults that could happen regardless of the level of foreign currency denominated debt a company has..
The picture that the data tell is one of some elevation in spreads over benchmark government bonds but not as dramatic as might be expected given a lot of commentary around emerging markets that treats them as a homogenous block heading for catastrophe (see the Finance Forward article on a recent BIS paper). This chart shows new corporate sukuk issuance since the beginning of 2014, compared to a relevant benchmark of Malaysian 5-, 7-, or 10-year bonds.
To account for the possibility that the chart above reflects a shift in issuers, the chart below shows similar data only for those sukuk for which there is ratings data in Zawya Islamic where the average spread for the sukuk’s rating is subtracted from the sukuk’s yield spread over Malaysian government bonds which is shown in the table to the right of the chart (all the bonds in the sample were rated AA3, AA2, AA1 or AAA by local credit rating agencies).
Despite a different methodology, the result is more muted. While spreads have risen a little, they have not risen uniformly and it is more a few select issuers whose new issues are being repriced and the mix of issuers towards lower rated issuers. That is consistent with some impact of an economic slowdown on risk premia but not the repricing of risk to imply that there is a full-blown crisis in the future.
Regenerating Trust in the Investment and Finance Industry
The Principles for Responsible Investment, the leading set of RI principles is revisiting its impact to increase the transparency of ESG assessments and better allow their stakeholders to gauge their effectiveness. Below, Karen Wendt, the Editor of Responsible Investment Banking offers an alternative way to think about effectiveness with the idea of Positive Impact Investment and Finance.
In the last few years financial institutions and institutional investors are in the spotlight for a number of reasons. They are criticized for financing emissions (buried in their portfolio’s investments). They are accused of short selling their leverage when it comes to asking clients to act fully in accordance with human rights. Controversial projects carry reputational, environmental and social risk for financial institutions. Institutional Investors are reminded of their fiduciary duties for climate and society.
The investment and finance industry needs to revisit the current business model for a number of reasons: Banks and investors need to understand extra-financial risk, which can be defined as risks that are coming from the sphere of environment, society, politics, technology and organizational models and, increasingly, also their fiduciary duties. They need the metrics to calculate the impacts and outcomes, not just the output of their investments and projects.
There is also impact on society if they do not invest in the real economy, but in financial instruments. The ‘secondary circuit of capital’ has been a focal point for debate in the financial sector and a key element in the contemporary discussions on “financialization”. In an article (“Financial Innovation, Leverage, Bubbles and the Distribution of Income” published in 2011), Margaret M. Blair stated that “Financial services and financial innovation undoubtedly facilitate productive investment up to a point. But, in the last few decades, the U.S. economy has invested a growing share of GDP in a financial system that, at least at the margin, is using too much debt, creating too much credit and absorbing more in the way of social and economic resources than it is producing.”
Stakeholders increasingly demand more sustainability as well as transparency of banks’ and investors’ activities. Integrating sustainability and ethical values into the whole value chain of a financial institution or institutional investor is an ongoing and challenging task and banks and investors can be easily accused of “greenwashing”. To mitigate the challenges banks and investors began in a first step to analyze their own internal purchasing procedures, product development and internal organizational systems.
In a second step they started to map out the context factors which matter for them, for clients or projects they want to finance or to invest in and developed environmental and social governance, soft law standards and criteria in collaborative approaches such as the Equator Principles and the UN supported Principles for Responsible Investment (PRI). Coincidently, the role of fiduciary agreements and duties of investors have been undergoing a redefinition process and now focus increasingly on investors’ responsibility towards society and their fundamental ethical norms.
Bank and investors now need models to calculate the risks and impacts that context factors pose to investment and finance in monetary terms. The investment triangle of liquidity, risks and return is now complemented by a forth component: impact or – in other words – the ethical use of funds. Clients want to know – and institutional investors and the banking industry need to show – how they use clients’ money. This entails the due application of environmental and social governance. While conventional wisdom states that Environmental and Social Governance (ESG) is a necessary cost center that reduces reputational, operational or credit risk, ESG can likewise be a framework for profit creation and strategic direction and add value throughout the investment process, from selection to exit. For example, Initial Public Offerings (IPO) sell much better, when they have a functioning environmental and social management system.
A new and proactive approach in investment and banking considers the opportunity side by creation of shared value and positive impacts. Global megatrends will force society, business and banking to extend value creation beyond financial goals in order to take environmental and social solutions on board. This applies in particular to population growth, climate change and adaptation, ecosystems services, human rights and labour, fresh water and access to food and agricultural services. In all of these areas, the financial system is called to duty as problem solver, as political solutions start to play a role only slowly.
Positive Impact Investment and Finance puts the creation of positive impact center. It is ingrained into strategy, product development, technological innovation and supply chain transformation. A number of products currently emerge in this field; while some of them are still small, many have the potential to become mainstream. Hence positive impact investment is very different to socially responsible investment (SRI), which uses screenings to avoid portfolio exposure to socially or environmentally harmful investments. In contrast, Positive Impact Investing seeks to create pro-actively positive impacts and to direct additional money into projects in the real economy.
While SRI reduces the investment universe by application of exclusion lists, impact investing enlarges the investment universe through investments in the real economy. Will Positive Impact Investing and Finance help to regain the trust that has been lost into financial Institutions and even Institutional Investors? If it creates volumes for social and environmental innovation, it is certainly a tool that is capable of aligning interests of investors, social or green entrepreneurs and society.
Thomson Reuters Digital Islamic Economy Report
Muslim consumers contributed US$107 billion to global digital economy of nearly US$2 trillion, and their spending will grow faster than the rest of the digital economy by 2020