Capital Market: Debt

1
Topic Outline
 Debt market instruments
 Market players and institutions
 Credit rating
 Islamic capital market: Sukuk
 Current developments
 Capital Market Master Plan 2

2
Introduction
 What is a bond market?
 How does the bond market promote the
economic development process of a
country?

3
Debt instrument
 A debt instrument is a paper or
electronic obligation that enables the
issuing party to raise funds by promising
to repay a lender in accordance with
terms of a contract. Types of debt
instruments include notes, bonds,
debentures, certificates, mortgages,
leases or other agreements between a
lender and a borrower.
(Investopedia)
4
 An investor who purchases a debt
instrument is essentially loaning her
money to the issuer, which could be a
government, bank, corporation,
business or some other entity. In return,
she usually receives compensation in
the form of interest payments and the
return of her principal.

5
The Malaysian Bond Market
 Started in 1970s
 Raise funds for country’s development
projects
 Bond issuers – started with the Govt and
later mostly by the private sector
 During 1980s – main source of financing
 After the 1997-98 Asian financial crisis, there
had been a conscious shifts towards the
bond market. Why?

6
The Malaysian Bond Market
 Why we need a strong bond market:
1. Financing
○ Investors demand large amount of finance
for the purpose of making investment
2. The shift from labour intensive to capital
intensive industries demands long-term
debt financing – investment in fixed assets
3. Long-term institutional investors need
funds for portfolio diversification and asset
liability management purposes

7
Who are the Issuers in the Malaysian
Bond Market?
 Government of Malaysia
 To finance working capital and development
expenditure
 How? By issuing diverse forms of govt securities
○ Malaysian Treasury Bills (short term) – working
capital
○ Interest-bearing long-term bonds – development
expenditure
○ Non-interest bearing securities based on Islamic
principles
 Government Investment Issue
 Malaysian Islamic Treasury Bills

8
Who are the Issuers in the Malaysian
Bond Market?
 Bank Negara Malaysia (Central Bank)
 Issue bonds to manage liquidity in both
conventional and Islamic financial markets
 Allowed to purchase Malaysian Government
Securities (MGS) from the primary and
secondary markets and used them for its
open market operations. What is open
market operation?

9
Who are the Issuers in the Malaysian
Bond Market?
 Securities issued by Bank Negara:
○ Bank Negara Monetary Notes
 Discounted or coupon bearing govt securities with
maturity of 91,182, 364 days and 1-3 years
 To manage liquidity
 Replaced BNM Bills and BNM Negotiable Notes by Dec
2006
 Offered through competitive auction
○ Sukuk BNM Issues
 Zero coupon bonds with maturities 1-2 years
 Based on Ijarah (sale and lease concept)
○ Merdeka Savings Bonds
 Targeted at retirees
 Based on Islamic banking concept of Bai’ Al-Inah (sell
and buy back arrangement)

10
Who are the Issuers in the Malaysian
Bond Market?
 Quasi-government Institutions
1. Khazanah Nasional Berhad
○ Empowered as the government’s strategic investor and
trustee to the nation’s financial assets
○ To promote economic growth and make strategic
investments on behalf of the govt which would
contribute towards nation building
○ Select strategic industries and nurture their
development through the issuance of zero coupon
Khazanah Bonds (based on Islamic principle with
maturities of 3, 5, 7 or 10 years) guaranteed by the govt
○ An example of sukuk issued by Khazanah: refer to
http://www.khazanah.com.my/About-Khazanah/Our-
Case-Studies/Khazanah-360/Sukuk-Ihsan-Sustainable-
and-Responsible-Investme

11
Who are the Issuers in the Malaysian
Bond Market?
2. Pegurusan Danaharta Nasional Berhad (now
managed under prokhas sdn. Bhd.)
○ A public company incorporated under the
Companies Act 1965
○ Wholly owned by the Malaysian Govt.
○ To act as the national asset management
company
○ Its principal objectives are to re-energize the
Malaysian financial sector by buying non-
performing loans (NPLs) and maximize their
recovery value
○ Has a special power to acquire, manage and
dispose of NPLs and assets

12
○ Prokhas Sdn Bhd is a private limited company
wholly-owned by Minister of Finance,
Incorporated initially established to manage
the residual assets of Danaharta after it
closed its chapter on 31 December 2005.
Danaharta was a success story on its own,
where it had managed to achieve its NPL
recovery mission during the Asian financial
crisis and further assist to re-energise
Malaysia’s financial sector. Prokhas was then
entrusted to continue Danaharta’s work and
maximise the recovery value of the residual
assets.
(http://www.prokhas.com.my)

13
 Prokhas has been mandated to manage the
operations of few companies under Minister of
Finance Incorporated namely Pengurusan
Danaharta Nasional Berhad, Danainfra Nasional
Berhad, Syarikat Jaminan Pembiayaan
Perniagaan Berhad and Syarikat Jaminan Kredit
Perumahan Berhad.
 In running the companies’ day-to-day operations,
Prokhas provides full spectrum of services ranging
from secretarial services, human resource, finance
and many more to the companies. This allows the
companies to operate without having to have
physical offices and manpower thus reducing the
operation cost of the companies.

14
Who are the Issuers in the Malaysian
Bond Market?
 Cagamas Berhad (National Mortgage
Corporation)
 Established in 1986
 The leading “securitization house”
○ Securitization is the process of taking an illiquid asset,
or group of assets, and through financial engineering,
transforming them into a security.
 Promote the secondary mortgage market in
Malaysia
 Issues debt securities to finance its portfolio of loans
and debts purchase for its housing loans, industrial
property loans, hire purchase and leasing debts,
Islamic house financing and hire purchase debts

15
Who are the Issuers in the Malaysian
Bond Market?
 Cagamas debt securities include:
 Cagamas Fixed Rate Bonds
○ 1 ½ -10 years, fixed coupon rate
 Cagamas Floating Rate Bonds
○ Up to 10 years with adjustable interest rate
pegged to 3-month or 6-month KLIBOR rate
 Cagamas Notes
○ Short-term with 1-12 months
○ Issued at discount
 Sanadat Mudharabah Cagamas
○ Islamic bonds based on profit sharing
arrangement

16
Who are the Issuers in the Malaysian
Bond Market?
 Multilateral Development Banks
 Refer to World Bank Group, five regional
development banks, the Global Environment Facility
and the International Fund for Agricultural
Development
 Their objective is to provide financial support and
professional advice to the developing countries in
terms of economic and social development activities
 Their sources of funds:
○ Borrow from international capital markets and re-lend to
the govts of developing countries and charge market
interest rates
○ Lend donated money and charge low interest rates

17
 Investors in the Malaysian Bond
Market
 Employees Provident Fund
 Pension Funds
 Unit Trusts
 Insurance Companies
 Asset management companies
 Discount houses
 Commercial banks
 Islamic banks
 Investment banks
 Securities companies
 Finance companies

18
 Debt Securities Products
 Types of Government Securities
 Malaysian Treasury Bills
○ To finance short-term capital requirements
○ Issued at discount through competitive auction facilitated by
BNM. So, the return?
○ 3-months, 6-months, 1 year
○ Actively traded in the secondary market
 Malaysian Islamic Treasury Bills
○ Short-term
 Malaysian Government Securities
○ Borrowings of the Govt.
○ To finance long-term development project
○ Fixed rate coupon bearing bonds, coupon payment made semi-
annually
○ Issued by auction and by subscription, can be bought in the
secondary market and from BNM
○ Tenure of 3-20 years

19
 Debt Securities Products
 Government Investment Issues
○ Long-term non-interest bearing government
securities based on Islamic principles to finance
developmental expenditure
○ Issued through competitive auction by BNM
○ Based on Bai’Al-Inah principle where the Govt will
sell a specified nominal value of its asset and
subsequently will buy back the assets at the
nominal value plus profit through a tender process
○ The profit rate will be distributed on a half-yearly
basis
○ Maturities of 3, 5, 7 and 10 years

20
Corporate Bonds
 Fixed Coupon Bearing Bonds
 Straight bonds
○ Fixed coupon rate, tend to carry high interest rates
 Bonds with detachable warrants
○ What Does Detachable Warrant Mean?
A derivative that is attached to a security and gives the holder the
right to purchase an underlying security at a specific price within
a certain time frame. A detachable warrant is often combined
with various forms of debt offerings and can be removed by the
holder and sold in the secondary market separately.
○ Detachable Warrant
Many companies choose detachable warrants when issuing
bonds because it makes a debt offering more attractive and can
be an effective method of raising new capital. The exposure to
the right given by the detachable warrant can often gain the
attention of investors who do not usually participate in the fixed-
income markets.
○ A detachable warrant can be traded independently of the
package with which it was offered, and is similar to a call option.

21
Corporate Bonds
 Floaters
○ Interests are tied to some measure of current rates
 Zero coupon bonds
○ No periodic coupons are paid
○ Sold at discount
 Asset-backed securities
○ Securities backed by assets such as mortgages
 Convertible bonds
○ Give the holder the right to convert the bond into a
specified number of shares
○ Lower coupon rate
 Callable bonds
○ The issuers have the right to call back the bonds before
maturity

22
Islamic Capital Market: Sukuk
 Sukuk commonly refers to the Islamic equivalent
of bonds.
 As opposed to conventional bonds, which merely
confer ownership of a debt, Sukuk grants the
investor a share of an asset, along with the
commensurate cash flows and risk.
 Sukuk securities adhere to Islamic laws which are
known as the Shari’ah principles, which prohibit
the charging or payment of interest.

23
Islamic Capital Market: Sukuk
 As a marketplace for global sukuk, Malaysia
issued US$77.9 billion or 66% of the total global
sukuk that was issued for the year 2014.
 58% of the total sukuk outstanding globally is
domiciled in Malaysia, with a value of US$172.8
billion.
 Malaysia stands out as the only sukuk market with
global outstanding above US$100 billion.

24
Exchange Traded Bonds and
Sukuk (ETBS)
 Bonds/Sukuk have always been seen as
an asset class to hedge when markets
are bearish and a means to develop a
steady income over many years.
 In the past the bonds/sukuk market was
accessible only to high net worth and
institutional investors.
 Now with ETBS, all investors can have
access to the bond/sukuk market with
ease, via the stock market.
25
ETBS
 What are ETBS?
 ETBS are fixed income securities, also
known as bonds or sukuk*, that are
listed and traded on the stock market.
ETBS are issued either by companies or
governments (the issuer) to raise funds
for their needs. ETBS have varying
structures such as fixed rate, floating
rate and hybrids.

26
 What are the minimum investment
units?
 ETBS are traded in minimum board lot
size of 10 units per lot size. Given the
principal price of RM100.00 per unit,
each board lot will cost RM1000,
excluding transaction costs.

27
Bond Pricing Agencies
 What is the purpose of having a rating?
 The Purpose of Bond Ratings. Often,
before a borrower issues a bond, the bond
will receive a rating from one or more credit-
rating agencies. These ratings act as a
measurement of the likelihood that the
lender will be able to pay the bond on time
and in full.

28
Bond Pricing Agencies
 The rating agencies are independent
from bond issuing companies.
 Focus on credit analysis of issuing
companies
 Rating Agency Malaysia Berhad (RAM)
established in 1990 and Malaysian
Rating Corporation Berhad (MARC)
established in 1996

29
Rating Process

30
Bond Pricing Agencies
 Rating Agency Malaysia Berhad (RAM)
 Provides independent credit research and
advisory services to its customers
○ Help in decision making
 Provides financial and credit expertise
through training as well as economic
research
 Refer from RAM’s website for the bond
rating definitions

31
RAM
Corporate Credit Ratings (National) - RAM Ratings' current opinion on the
overall capacity of an entity to meet its financial obligations

Long-Term Ratings

AAA An entity rated AAA has a superior capacity to meet its financial obligations. This is
the highest long-term CCR assigned by RAM Ratings.
AA An entity rated AA has a strong capacity to meet its financial obligations. The entity
is resilient against adverse changes in circumstances, economic conditions and/or
operating environments.
A An entity rated A has an adequate capacity to meet its financial obligations. The
entity is more susceptible to adverse changes in circumstances, economic
conditions and/or operating environments than those in higher-rated categories.
BBB An entity rated BBB has a moderate capacity to meet its financial obligations. The
entity is more likely to be weakened by adverse changes in circumstances,
economic conditions and/or operating environments than those in higher-rated
categories. This is the lowest investment-grade category.
BB An entity rated BB has a weak capacity to meet its financial obligations. The entity
is highly vulnerable to adverse changes in circumstances, economic conditions
and/or operating environments.

32
Bond Pricing Agencies
 Malaysian Rating Corporation Berhad
 Provides ratings and comprehensive
research services
 Refer to MARC’s website for the MARC’s
long-term ratings and short-term ratings

33
Bond Pricing Agencies
 Standard & Poor’s
 A global and independent rating agency that
provides credit ratings and credit risk analysis
 Moody’s
 Involves in credit ratings, research and risk
analysis

 Credit ratings and research help investors

analyze the credit risks associated with
fixed income securities

34
 The Difference between Bonds/Sukuk and Shares
Bonds/Sukuk
Bonds/Sukuk are Debt Securities
Bonds/Sukuk holder - they are the
owner of a bond asset and do not
have rights to the ownership of the
company
Steady flow of payments known as
coupon/dividends
Generally less volatile
Time limit or maturity period
Trade size is 10 units
Shares
Stocks are Equity Securities
Shareholder - an owner of the
company
Dividend payments based on the
policy and performance of the
company
Impacted by market volatility and
forces
Do not have a maturity period,
unless delisted
Trade Size is 100 units
35
Capital Market Master Plan 2 (CMP2)
2011-2020

“….CMP2 outlines the strategies to transform the

competitive dynamics of the capital market over the
next 10 years.”

“CMP2 focuses on addressing the structural

weaknesses, and enhancing efficiencies in critical
linkages in the capital market, to foster a more
diverse and innovative intermediation environment
and to nurture new growth opportunities.

36