A new way for financing East Asia integration process?


Infrastructure development has been identified by many as THE main stumbling block to making actual progress on integrating the countries within the East Asia Region; giving thus to the region as a whole and to its member countries a new geopolitical power.

The fact is that infrastructure projects are many throughout all the countries within the region but the financial resources available are few. Furthermore, different regional sectors are always competing for securing the appropriate financial resources to implement their projects.

Some members of this East Asia region – notably Malaysia – claim that new sources of financing are available to speed up the building up and maintenance of the regional infrastructure network.

Purpose of this paper is to analyze how feasible this new financing vehicle is and how it can be engineered.

The Role of Islamic Finance

East Asian governments may involve banking by means of publishing a current treasury certificate for payment instruments in public investment projects, to develop the country’s infrastructure, for example, the building of highways.

Developing highways has three simultaneous positive effects on the economy. It provides employment to address the critical problem of unemployment, it expedites the flow of economic resources and it increases output of economic growth.

In addition, the projects can also be financed through the Islamic profit-sharing banking system, through Sukuk, or government bonds.

Indeed, an emerging financial trend is that for many large-scale projects, fund procurement is being done through a combination of conventional financing and Islamic Finance, by the issuance of Sukuk or Islamic bonds.

Delivering her keynote speech at the ‘Malaysia as a Global Sukuk Centre: Towards Greater Vibrancy of Malaysia Sukuk Market’, the Governor of the Malaysian Central Bank, Dr Zeti Akhtar Aziz stated:

“The growing role of Islamic Finance in mobilizing and channelling funds to productive investment activities across borders contributes to more efficient allocation of funds across borders and facilitates international trade and investment. Greater diversification of risks also contributes towards promoting international financial stability. The more recent developments in Islamic Finance are the growing significance of the Sukuk market to become an increasingly important component of the Islamic Finance system.

“Five major trends are having a significant bearing on the future development of the global Sukuk market. Firstly, the bond market is now becoming key to meeting the funding requirements for both the public and private sectors in emerging market economies. Secondly, while there has been growing interest in the issuance of Sukuk by corporations, sovereigns and multinational corporations, the demand for Sukuk significantly exceeds the supply. The significant demand for Sukuk has been spurred by the high levels of surplus savings and reserves in Asia and in the Middle East. This has been reinforced by increased liquidity in the international financial system in search of higher returns and greater diversification of risk. Thirdly, there is a large number of global players, such as investment banks, Islamic banks and securities firms that are involved in the issuance of Sukuk in the international financial markets.

Fourthly, the established international financial centres have also shown interest to have an active role in promoting the development of the Sukuk market including enacting the appropriate legislative provisions. Finally, the regulatory and supervisory paradigm continues to evolve.”

And then focusing on the role of Malaysia in the international Sukuk market, she added:

“In 2007, Malaysia accounted for about two-thirds of the global Sukuk outstanding, amounting to about US$47 billion. Malaysia not only represents the largest Sukuk market in terms of outstanding size, but also in terms of number of issuance.

“In promoting Malaysia as an international Islamic Financial Centre, we claim to develop Malaysia into a centre for the origination, distribution and trading of Sukuk to provide further impetus to the development of an increasingly vibrant and progressive bond market in Malaysia as well as in the Asian region. This would reinforce the international dimension of the Sukuk market in Malaysia by providing linkages with international issuers and investors.

“As part of our ongoing efforts to position Malaysia as an attractive gateway for the issuance of Sukuk, a number of legal and regulatory requirements are further customized to reduce the cost of Sukuk issuance. Malaysia has also put in place an efficient platform for trading of bonds including the Real-time Electronic transfer of Funds and Securities System, to provide post-trade transparency and market liquidity on par with developed markets.

“An important enabling factor driving innovation is the availability of the pool of experienced talent. There are currently 9,000 staff with the Islamic Financial Institutions. They are also reinforced by the workforce of domestic and foreign conventional financial institutions.”

Growth of Islamic Finance: Implications

The drive behind Islamic Finance phenomenal growth is plain old supply and demand on the one hand, and a shift in cultural trends and attitudes – both customers and providers – on the other. What is the implication? There is a large population for whom these services are attractive, more products to offer, an increasing trust in the sector, younger generations’ interest propelling the momentum, and an industry interested in both filling a market need and offering a product with inherent social value.

It implies, therefore, also that these Islamic Finance institutions are transforming themselves to address new market challenges and optimize their offerings for greater cost efficiency and profitability. Forced to provide differentiated customer service, scale up operations to meet global competition and grow market share to increase their customer base, Islamic Finance institutions are reinventing their business models by shedding their initial niche status. Table No.1 illustrates, therefore, the evolution of Islamic Banking.


  • Retail Banking
  • Retail Banking
  • Project Financing
  • Syndication
  • Retail Banking
  • Project Financing
  • Syndication
  • Equity
  • Ijarah (leasing agreement)
  • Retail Banking
  • Project Financing
  • Syndication
  • Equity
  • Ijarah (leasing agreement)
  • Sukuk (bonds)
  • Structured products
  • Retail Banking
  • Project Financing
  • Syndication
  • Equity
  • Ijarah (leasing agreement)
  • Sukuk (bonds)
  • Structured products
  • Wealth management
Source: Asian Banker Research

Such a double-digit growth also implies that key steps have been required for IF to sustain long-term growth while the sustainability of IF will rest in how the international community builds on the momentum achieved thus far. In the words of Dr Zeti:

“Three key elements will be important in sustaining the current momentum: investing in research and development, leveraging information technology, and developing human capital with expertise in Islamic Law and experience in international finance. How the international community builds on the momentum achieved thus far would require:

  • Further deepening efforts to enhance the legal and regulatory framework of IF consistent with international practices;
  • More cooperation and vigilance on the part of home and host regulators;
  • Launching aggressive efforts to implement evolving Islamic financial regulatory and supervisory standards and to capture the different types of risks associated with IF while launching consumer protection frameworks.”

Globalization, from an economic perspective, sees the growing integration of world markets and economies. From a financial point of view, the internationalization of financial flows calls for a diversification in financial markets.

Indeed, financial markets are integrating rapidly in East Asia due to the deregulation of domestic financial systems, opening of financial services, and progressive relaxation of capital and exchange controls. Foreign operations by developed country commercial banks and portfolio investment by institutional investors in developed markets have significantly strengthened linkages among the region’s financial markets. Commercial banks in emerging East Asia have also been expanding their businesses in their neighbors’ countries. One result was a rising degree of cross-country correlations of regional interest rates and stock market returns across East Asia.

Compared with trade and FDI integration, however, regional financial integration in East Asia has been less pronounced: cross-border portfolio investment flows – particularly equity investment flows – have been expanding among the East Asian economies, but the share of intraregional portfolio investment flows in East Asia is still low (a mere 6% in 2005) compared with those of the EU – 15 (62%) and NAFTA (16%). The reason being, in part, Japan, Hong Kong, China, and Singapore; and in most part because many countries in East Asia still impose significant capital and exchange restrictions and other barriers which impede free flows of financial capital; domestic financial systems of many emerging market economies are still underdeveloped and shallow and, thus, cannot attract regional investors. East Asia investors tend to direct their international portfolios in North America and Europe, rather than in East Asia. Furthermore, according to Mr Edmond Lau, Executive Director (Monetary Management), Hong Kong Monetary Authority, financial integration in Asia, as compared to international integration generally, “is probably less developed”.

While Table No.2 illustrates the roadblocks in the East Asia Financial Integration process, Table No.3 points out the key elements that are needed to strengthen financial intermediation and developing Islamic capital markets in East Asia and Table No.4 on how to integrate.


Large national differences in market practices. Constraints to cooperation
Institutional and infrastructure development.
  • Barriers to foreign entry.
Regulatory standards. They need to be flexible and effective, due to the evolving and dynamic nature of the finance industry.
  • Regulatory conservatism towards financial innovation. Regulatory and Supervisory authority should not be constructing factor, but rather a facilitator of sound growth, a promoter of creativity, a provider of a level playing field, a builder of institutional capacity, a contributor to functional markets, a supporter of effective infrastructure.
Laws and processes that lead to high transaction costs.
  • Supporting institutions, laws, regulations, supervision, oversight, and standardization.
Momentum and recoil of spontaneous integration and the government-driven quest for closer integration. The forms of spontaneous integration are: integration initiatives from government are slow-moving and superficial; private capital flows dwarf corresponding provisions of government budgets; the private sector is mainspring to technology; spontaneous integration extends to criminal and terrorist networks; spontaneous integration influences government behaviour profoundly. Same religion, different Shariah interpretation.

Different interpretations of product Shariah-compliancy can primarily be attributed to scholastic differences within Islam. The five teachings, Shafii, Shia, Hanafi, Hambali and Maliki all have subtle differences.

Very large socio-cultural differences among different people spread across the East Asian region. Islamic financial instruments without markets will only be a drag on Islamic Finance development.
Market development is needed for proper risk management as well as cash-flow management. Thus, elements of diversity and depth require careful attention in primary market development. The nascent commercial interest in establishing strong commercial presence regionally.
The region has yet to show bigger intraregional transactions, while capital markets have yet to deepen. Each domestic economy in the East Asia region remains highly protected by different regulations and restrictions on capital flows.


Financial market integration occurs through the following range of channels to facilitate investors in one jurisdiction to transact or finance economic expansion in another
Strategic Alliances among exchanges largely driven by market forces and determined mainly by commercial considerations
Harmonization of standards
Mutual recognition regimes
Cross-border issuances
Depository receipts and expansion of intermediaries through branch offices and alliances

Shariah law is open to interpretation and religious boards frequently hold different views on key Shariah issues. Furthermore, Islamic jurisdiction is not bound by precedent, and legal opinions may deviate from previous decisions made by Shariah scholars. Thus, a Shariah board has considerable discretion in the interpretation of Islamic Law and may choose any school of thought to inform its decision-making process.

The Achilles heel in the global acceptance and growth of Islamic Finance is the level of standardization of the Shariah board’s rulings. There is yet to emerge a consistent ruling of Islamic Law on the religious compliance of certain assets and transaction structures in terms of Shariah Law. Shariah boards from different Islamic Financial Institutions may have different interpretations and advise differently because, in Islam, there is no generally accepted codification of the jurisprudence. In a conventional sense, that can lead to uncertainty and confusion. The absence of a universally accepted central religious authority is largely a result of the lack of uniformity in religious principles applied in different Islamic countries across the world. However, the functions and role of these Shariah Boards are always: to provide advice to Islamic Financial Institutions; to supervise and audit transactional procedures of Islamic Financial Institutions; and to supervise and actively participate in the creation of innovative Shariah-compliant investment and financing products and services.

Many scholars argue that the existence of a unified Shariah board via a council representing different Islamic schools of thought, nationally and internationally, is necessary. This would facilitate the conformity of different types of financial services to Islamic Law and in addition would define cohesive rules to expedite the process of introducing new products.


Establish links between jurisdictions across the whole spectrum of financial structure – the trading, payment, clearing and settlement and custodian system for money, debt and other financial instruments – since these provide the basic infrastructure for the movement of savings between jurisdictions and make cross-border transactions more efficient. Relaxation of non-supervisory restrictions, where they exist, on access by foreign financial intermediaries to the domestic markets.
Harmonize standards in the financial system. This consists of: market harmonization of standards on a practical and operational perspective; and harmonization attributable to the regulation and supervision of Islamic Finance products. Strengthen regional co-operation. It can expose regulators to developments elsewhere in the region and create an environment conducive to a higher degree of regulatory harmonization and increase the diversity of financial intermediation channels in individual jurisdictions in the region and sharing experience in development efforts.
Satisfy the need for greater capital mobility. It is hard to advocate lifting all restrictions on cross-border investments as this would depend on the ability of the financial systems in individual jurisdictions to cope with the ensuing risks. Satisfy the need to nurture a larger pool of talent with expertise in Islamic Finance. Today the talent pool is too small to meet global needs. Thus, new entrants have to leverage on the expertise of major international banks in structuring Shariah-compliant financial products. And these experts are already very limited.
Know how to work together. The lack of knowledge and experience in working together is the single most dangerous factor to promoting the stability, integrity, diversity and efficiency of financial intermediation across jurisdictions in East Asia. Yet, it is crucial that East Asian markets work more closely together to seize the opportunities brought by IF. Lack of relaxation. The lack of relaxation of controls on cross-border transactions cannot drive more efficient allocation of resources; avoid financial openness crucial to the attraction of global players in entering into IF businesses in local markets.

The differences in interpretation of Shariah laws mean that one Islamic bank may not be able to “copy” another Islamic bank’s products, and this can stifle the growth and integration of IF at both national and international levels. The lack of standardization is a contributory factor to the sluggish trading level on the Sukuk market.

Strategic Considerations

At the 5th Islamic Financial Services Board Summit in Amman, it was pointed out that:

In terms of economic integration, the most comprehensive model is the European Union where integration involves freedom of movement of goods, services, labour and capital, as well a monetary union through a common currency and a political union through a common parliament.

In terms of market integration, greater cross-border investments will generally facilitate pooling of liquidity and risks and improve the efficiency of the capital allocation. More efficient capital allocation will promote faster economic growth. Capital market integration will also enhance the ability of the region to compete for capital and order flows while aligning national regulatory approaches will reduce the costs of operating in the regional market.

One key aspect of the integration strategy must be to promote the recycling of surplus savings in some Islamic nations to finance economic development in other Islamic countries. Hence, collaboration through market integration can expand intermediate activities in a positive and mutually reinforcing process that will grow both economies and markets and, in turn, strengthen the brand value of Islamic capital markets.

Catalytic Role of Government and Regulators

The Chairman of the Malaysia Securities Commission, Dato’ Zarinah Anwar, discussing in the abovementioned international summit on ‘Regional Integration of Islamic Capital Markets’ held in Amman, Jordan on 13-14 May 2008, reflecting on the catalytic role of governments and regulators, pointed out:

“Efforts to promote the various forms of market integration require the strong active support and involvement of government and regulators. There is therefore a major role for OIC governments and regulators to play in terms of creating an enabling environment to facilitate a sequenced and orderly integration of Islamic capital markets.”

After having indicated that the integration of the Islamic capital market can be accelerated through greater collaboration to promote the growth of markets through the OIC, she applauded the joint initiative of the Islamic Development Bank (IDB) and the Islamic Financial Services Board (IFSB) for their 10-year Framework & Strategies for the development of a dynamic, comprehensive and innovative Islamic financial services industry that is well integrated within the international financial system.

And then she affirmed that:

“Infrastructure projects can have strong multiplier effects on economic growth and can significantly improve the welfare of the population. Another potential benefit is the possibility of using the mechanism of fast-track corporate sector development through creating listed vehicles, which would undertake or own infrastructure projects. At the same time, there is also a need to intensify international collaboration on Shariah standards. Lastly, Islamic Finance practitioners should also collaborate to promote greater awareness of the virtues of Islamic financial products and also ensure greater reach to savers.”

Financial Integration: Europe vs East Asia

By financial integration, we are not referring to the monetary union leading to a single currency condition, but more to the integration of financial services sectors. Thus, it focuses more on improved facilitation of cross-border financial flows rather than discussions of optimal currency areas and other macroeconomic aspects.

It follows then that comparing the European financial integration process with the East Asian one, some lessons can become evident. They are illustrated in Table No.5



Sequencing of Financial Reforms. The removal of capital controls after domestic financial reforms and strengthening of supervisory capacities, the almost simultaneous application of deregulation (for structure and conduct) and re-regulation (for prudential rules), the principle of “mutual recognition” of financial sector licences, and “home country control”, effectively facilitate full market access.
Cross-border Settlement of Payments. They have been adapted to the modern global financial system.
Monetary Union. Europe achieved the Monetary Union without a major regional financial crisis or large bank bankruptcies. So, strong liberalization and bank de-regulation must be accompanied by an equally strong re-regulation of bank prudential supervision. The EU carefully balanced de- and re-regulation.
Balance Achieved. This balance was achieved through harmonization of minimum regulatory standards while adopting the principles of “mutual recognition” and “home country control”. A harmonized regulatory framework was established prior to effecting the large-scale liberalization and deregulation associated with SMP.
Competition Policy. The consolidation trends that result from the perceived greater competition were tempered by a clear competition policy.
Public Persuasion. The SMP put the emphasis on public persuasion regarding the benefits of liberalization and integration. The EU embarked on a strenuous public program aimed at stressing the timetable and the inevitability of the liberalization events, providing significant lead time to expectations built-up. East Asia is not prepared to embark on any specific timetable and financial liberalization.
Supranational Authority. The EU implemented the integration of financial systems with the strong guidance and supervision of a supranational authority, which East Asia does not have.
Interest Groups. While the EU bureaucracy is not immune to the influence of interest groups, public policies are not completely determined by them.
Facilitate market integration. Even as regional agreements enumerating legal rights to cross-border access should facilitate market integration by reducing regulatory entry barriers and legal uncertainties, the agreement that emerges from the political process contains rights that are severely circumscribed and liable to be subject to new restrictions.

In short, integration has been plausible and beneficial in both the European and East Asian experiences. However, in Europe, a concerted effort has been made in promoting technological development, raise human capital, and improve the product diversification among Muslim countries, while developing stable institutions and infrastructures. The potential benefit of integrating exceeded the cost. The emphasis was not in cutting costs/inputs (reductionist approach), but on generating more wealth/revenue/income (incrementalist approach), that results in reducing huge external debt, poverty, diseases, frustration, and corruption in most Muslim countries. Key to Muslim’s socio-economic happiness is through mutual cooperation for growth and development (Qur’an 42:38,Q3:159)

The Sukuk Challenge

The challenge is to put in place an intermediation system that will channel the surplus savings in both Europe and East Asia into productive investments. It is in this context that the Islamic capital market, in particular Sukuk market, will serve as an important avenue to efficiently mobilize longer-term funds to meet these funding requirements.

The Governor of Malaysia’s Central Bank, Dato’Akhtar Aziz, in her speech to the London 2007 Sukuk Summit, warned:

“The global experience has shown that the lack of well developed bond markets brings with it vulnerabilities arising from over-reliance on financing from the banking sector. This has often resulted in funding mismatches with adverse implications on financial stability. The development of the bond market allows for access to funding with the appropriate maturities, thus avoiding the funding mismatches. It also allows for the diversification of risks by issuers and investors.

“In the Middle East and in East Asia, two of the fastest growing regions in the global economy are taking place following privatization and implementation of infrastructure projects. Asia alone will be spending an estimated US$1 trillion on infrastructure over the next five years, while infrastructure requirements in the Middle East are estimated to be US$500 billion over the same period.” This is the Sukuk challenge.”

This network of challenges is mapped out in Table No. 6


Benefits to the issuers. They benefit from the huge increase in liquidity and can tap into these new sources of funds.
Benefits to the investor. They have the benefits of diversification.
Commitment. The growth in the Sukuk market reflects the commitment and combined efforts of the Malaysian government and regulators. There is a clear articulation of the vision and policies to drive the local Islamic capital market.
Key components. Linked to Sukuk development is the development of the other key components of the Islamic financial system, the money market, banking, and Takaful sectors.
Creation of a secondary trading platform. It is essential for the development of capital market instruments. This will provide investors with the flexibility in managing their liquidity requirements.
Diversity. There are also challenges of greater diversity in the type and maturity of the Sukuk in the market for Islamic Financial Institutions and portfolio managers to manage their funds effectively.
Pricing. It is another challenge to the growth of the capital market because for Islamic security to be efficiently priced and credible, further initiatives need to be undertaken to develop its own indicator.

Such Sukuk challenges are the result of overcoming other challenges. Examples:

The key regional challenge is to facilitate the progressive improvement of the investment climate for infrastructure as a pre-condition to attract domestic savings and international capital.

Similarly, coordination between decentralized government authorities is another challenge. Within less than 20 years, previously centralized state structures have been significantly decentralized. This shift requires a new relationship between central and decentralized governments as well as across decentralized authorities to coordinate the planning and financing of infrastructure.

Private investors are hesitant to invest unless supported by host governments through tax incentives, direct financing and guarantees intended to improve the infrastructure project’s cash flow or reduce risk. Such support is varied in scale and mix from country to country and from project to project. Four distinct types of government support emerge from a cursory review of recent infrastructure projects in East Asia: direct financing, guarantees, tax incentives and subsidies.

Another challenge is, of course, the availability of sufficiently long-term debt capital. That is, the availability of longer maturity debt reduces the risk that an infrastructure project’s cash flows may fall short of required amounts to service debt obligations when such payments become due. In the particular case of project financing, where loans would have to be paid from a project’s cash flows, and where creditors have no or limited recourse to the assets of the sponsoring company, loan maturity plays an important role in ensuring that the project can be financed.

The IFSB’s Professor Rifaat emphasized the fact that the challenges for the Islamic capital market has to be particularly focused on the management of balance sheet liquidity due to the lack of Shariah-compliant capital and money market instruments. Therefore, he stated:

“Given that the asset structures of a majority of Islamic Financial Institutions are illiquid and long-term in nature, while their contractual obligations to holders of profit-sharing and loss bearing investment accounts mean that funds can be withdrawn at any time, the lack of short-term instruments and a liquid inter-bank market imposes limitations on these institutions with respect to dealing effectively with liquidity mismatches between asset and liability portfolios.”

The development of bond markets is on the agenda of many countries in the region and will require greater issuance of government bonds, the development of incentives and institutions for contractual savings, and the establishment of infrastructure for bond issuance and trading. That is, while various financial schemes will turn out to be useful in creating supply and demand for Asian bond markets, a large number of market supporting institutions should be created to ensure stability and efficiency. They are: regional credit rating agencies, credit enhancement and guarantee agencies, clearing and settlement system, a central security depository, cross-border securities borrowing and lending mechanisms, and exchange and over-the-counter markets for bond trading. In addition, regional bond markets should be developed as an integrated part of the global capital market. The governments in the East Asia region hoping to create regional financial centres in their economies should be ready to open up their domestic financial markets to foreign investors, foreign issuers and foreign financial intermediaries.

The Malaysian Governor of the Central Bank, delivering her speech on 15 January 2008 at the Conference ‘Towards Gaining Global Growth Potential of Islamic Finance’ in Kuala Lumpur, stated:

“The increased pace of liberalization in the Islamic financial services industry has increased foreign presence and participation in our domestic Islamic financial system. This has increased the diversity of players in our system. The Malaysian bond market has also been liberalized to enable foreign entities to raise ringgit and foreign denominated funds in our domestic market. Following these developments we are now entering a new phase in the development of an Islamic financial system in Malaysia with the new initiatives to promote Malaysia as an International Islamic Finance Centre. This aims at strengthening our economic and financial inter-linkages and thus promoting greater trade and investment across borders. We are therefore entering a new phase of development for Islamic Finance in Malaysia as it becomes more integrated with the international financial system.”

From roads, ports, airports, water treatment plants, powers plants to schools and hospitals, construction projects have become key to economic growth in East Asia and governments and companies are searching for different alternative financial sources. These alternatives have recently started including also Islamic Finance. Indeed, infrastructure is a perfect use of Sukuk because you are raising funds that are to be used for a specific project. Assets that you create can generate a return. Thus, many Gulf nations are looking to transform into dynamic business and tourism hubs to insulate against a fall in oil prices and dwindling reserves, while East Asia urgently needs to upgrade and expand basic infrastructure to support economic development and reduce poverty. China, for example, has issued its first Sukuk when Kuwait Finance House targeted the Gulf with a US$200 million deal for a Chinese government-linked power company.

There is the need to connect people to water supply and sanitation so that people can live their lives; you need to build safe roads so children can walk to school. Therefore, one has to ask what do people need? How to deliver these services? Hence, the ultimate question has to be addressed: the infrastructure projects we are referring to in this presentation – i.e. roads, ports, airports, water, power plants, comunications – what kind of level of overall investment is required?

Experts agree that the most urgent types of infrastructure development needed are in the transportation, energy, water, and telecommunications sectors. Indeed, they have reached a consensus because such infrastructure will open up new, previously undeveloped, areas to bring in development of rural regions, linking them to the rural areas. However, when it is necessary to transform general statements into precise dollars and cents figures, the perception of experts coming from different constituencies varies.

Yun-Hwan Kim, researcher at the Asian Development Bank, estimated that the investment level required by major countries in the Asian region to construct and improve physical infrastructure will vary? from US$20 to 30 trillion in the coming 10 years.

When studies for analyzing the feasibility of establishing the Northeast Asian Development Bank (NEADB) were carried out, estimates required investments in the Northeast Asian region – including Mongolia, Northeast China, DPRK and the Russian Far East – of US$7.5 billion a year for ten years, of which only US$2.5 billion could have been provided by the NEADB.

The World Bank, the Japan Bank for International Cooperation and the Asian Development Bank carried out the study ‘Connecting East Asia: A New Framework for Infrastructure’, covering 21 countries in East Asia, which estimated that the region needs annually about US$300 billion per year for infrastructure investment for the period 2006-2010 or about 6.2% of the region’s GDP. This estimate involved both new infrastructure investment (65%) and maintenance work (35%).

Finally, the most recent estimates have been published, in June 2008, by Merrill Lynch in a research report that raises the expected spending on infrastructure projects to US$2.25 trillion over the next three years, nearly double its earlier estimates.

Although all of the above estimates are staggering, what is relevant for our consideration on Financial Engineering, is a large financing gap between the funding required for infrastructure projects in East Asia and the funding currently available. That is, to keep pace with growth, annual financing needs for infrastructure investment and maintenance can be estimated to total 11% of regional GDP – or around US$300 billion per annum. Compare this to current estimates of the combined infrastructure investment of governments, donors, development banks and the private sector in East Asia – US$70-80 billion per annum – and you get a feel for the magnitude of the financial engineering for the infrastructure problem. If the region is to bridge this gap, cooperation on all fronts – public, private, bilateral, regional and multilateral – will be essential.

Hence, the potential role that Islamic Finance could play in East Asia.

However, in the past, such a type of investment was either not taken in due consideration at all or it was not approved by scholars. Many scholars are now coming around to the idea that Shariah-compliant hedging instruments are both acceptable and necessary. Yet, some of the major constraints to investments remain.

Major Constraints to Investments

Among the constraints to investments, the companies interviewed cited the lack of enforcement of contracts, inconsistencies in regulations and in the courts, corruption, but above all:

In the past, infrastructure has been a key driver of economic growth and for reducing poverty. Now the major constraint is getting the policies absolutely right because it is a priority for countries in the region to attract the private funds needed to promote economic growth and to share the benefits of that growth with poorer groups;

In order to continue the growth trend, East Asian countries must keep up with the demands of companies that need energy, reliable transportation links, and other services. Along with new investments, this will require a new kind of regional cooperation, both infrastructure and logistics, to maximize the benefits;

The industry is facing growing pains, with an acute shortage of lawyers and Islamic scholars who can advise companies and financial institutions on how to structure their investments and deals so as to comply with Islamic Law;

Firms are scrambling to get in on the action and are looking to ramp up lawyers with Islamic Finance expertise capabilities. The market for Islamic Finance lawyers is hot but there is a relatively small pool of them;

There is a lot of pressure because of demand to build more products, largely because of the oil and gas boom. Investors are looking for liquidity that is Shariah-compliant, but they are not too worried about the details. They feel that if it is good for the scholars, it is good enough for them;

Various Shariah supervisory boards in various countries are trying to find converging views. The goal is to find a formula that will satisfy market needs and be Shariah-compliant. The increase in growth in the market has been so high that people will have to fund a solution;

Western banks, which are largely responsible for developing and promoting such products, have a history of jumping into new territory quickly, only to have to pull back again. For investors though, products cannot be developed fast enough;

The lack of well-developed bond markets brings with it vulnerabilities arising from over-reliance on financing from the banking sector. This has often resulted in funding mismatches with adverse implications on financial stability;

Inadequate preparatory work leads to unanticipated problems and delays in implementing private sector infrastructure projects;

Infrastructure sectors are invariably subject to tariff regulation and it is difficult to strike a balance between ensuring that tariffs are sufficiently remunerative to private investors and ensuring that they are seen as fair to consumers.

In 2008, there has been, for the first time in five years, less Islamic bond issuances than conventional ones in the Malaysian market. Thus, Islamic bond comprised,in such an abnormal situation, only 30 per cent of the overall bond market issuance, while in 2007 constituted about 75 per cent of the overall bond market. The RAM Ratings Services Bhd’s Chief Executive Office, Wong Fook Wah, commenting on this situation at the launch of RAM’s handbook on the Malaysian sukuk market observed:

“This is more a question of timing rather than demand for sukuk. Once confidence comes back and we expect this to be in six months – we expect  issuance to re-emerge as the dominant trend and resume its double-digit growth.”

However, the former Prime Minister of Thailand, Thaksin Shinawatra, in his article ” How an Asian Bond could save us from the weak dollar”, published in The London Financial Times on 6 October 2008, stated:

“A number of Asian governments issue bonds in their own currencies. Their quality and performance vary. Asian bonds returns, taken in conjunction with their volatility, compared favourably with their US Treasury counterparts, market by market. However, an aggregate of Asian bonds gives a more positive picture. Part of the problem is the historical perception, perpetuated by rating agencies, that Asian countries are all borrowers,  just as the US has become. Now, some of these countries are there to lend. It is time they reaped the premium that is theirs as lenders. The value of their loans will be better protected if they take collective decisions. Their collective bond could be traded in Tokyo, Singapore, Hong Kong. This bond would contribute to the development of a healthy capital market in the region that can remain stable while the US works its way through its financial crisis. The greatest benefit would be that Asia’s surpluses will be recycled into productive assets in Asia.”

Differences and Consensus: Political and Economic

To develop a suitable environment both for inward investment and facilitating the creation of a platform for cross-border energy flows, the states of North-East Asia (i.e. China’s northeastern provinces, both Koreas, eastern Japan, Mongolia, and the Far East of the Russian Federation, an area neglected in terms of economic development compared with Southeast Asia) need to generate a consensus on three key issues: the desirability of inter-government cooperation in the energy sector; a commitment to the development of regional energy markets with transparent regulatory regimes and ready commercial access to international financial markets; and a recognition of the criticality of fostering stable market conditions to encourage the flows of international investment capital necessary for substantial production and infrastructure projects.

The political differences that have long divided the countries of Northeast Asia make it possible for outside powers to “divide and rule”. However, once the Northeast Asia economy is developed, it will contribute significantly to Asia’s value-added chain and become a participant in world trade, commerce and industry. But realizing this potential depends on the ability of the countries concerned to bring together the North’s natural and human resources with the South’s capital and technology.

If and when this political consensus is successfully engineered:

  • The funds for financing the infrastructure development will be generated by the public and private sectors. In the public sector, development agencies will always contribute to a small part of the overall financing picture. However, they still have an important role to play;
  • The governments will have to agree on those strategies they will carry out to attract private investment and ensure the continued evolution and spread of information and communication infrastructure;
  • Challenges ahead have to be met in institutional cooperation:
    • Economies of Asia are diverse and heterogeneous in terms of economic systems, per capita incomes, stages of economic and institutional development, and human and social conditions;
    • Asian countries are also diverse in political systems and in cultural and religious traditions, without shared history of political integration under a hegemonic power. As a result, establishment of a common value, mutual trust or strong political will for economic integration is one of Asia’s most challenging issues;
    • The region needs to maintain openness to the rest of the world, particularly North America and Europe, which remain important as markets for final products and sources of risk capital and innovative ideas.
    • The regional financial cooperation will have to build on its three pillars:
  • Creation of a regional liquidity support arrangement;
  • Establishment of surveillance mechanisms for frequent exchanges of views and consultations among regional-country financial officials; and
  • Development of Asian bond markets in view of the need to channel a vast pool of savings to long-term investment for growth and development within the region. This efforts reflects the recognition that the financial system in East Asia has been too dependent on bank financing domestically and on foreign-currency financing externally and, hence, needs to be strengthened through the development of local capital – in particular bond – markets. Hence the strategic importance of developing Islamic Finance for supporting infrastructure development in East Asia.

Some experts have compared the flow of capital for investment with running water, which always flows downward and seeks a lower level. In the physical world, such a difference in state creates energy. Likewise, capital is attracted to places that offer lower wages and have lower levels of technology.

Downward capital flows, if harnessed properly, can create economic value. In the process of regionalization, the synergy of comparative advantages can be reinforced by the complementarity that exists between different industrial structures, technological levels and demographic features. Northeast Asia, therefore, has great potential due to national and provincial differences in the level of development. Given these differences and regional diversity, interactions among these factors can generate dynamism in the regional economy as a whole, and this will be the force behind economic integration in Northeast Asia.

Furthermore, in order to work for developing greater regional financial cooperation, several motivations will have to come into action: learning and applying the hard lessons from the 1997 Financial Crisis in terms of effective prevention; management and resolution of it; dissatisfaction with the existing global financial system governed by the IMF; greater efficiency in managing regional financial issues through internationalization of externalities/spillover effects; and greater Asian voice in global financial architecture.

Cooperation is no stranger to the countries of East Asia. There are approximately 48 different cooperation mechanisms under the ASEAN+3 processes. Regional financial cooperation among the ASEAN+3 countries alone, for example, has five initiatives to date: the Economic Review of the Policy Dialogue (EPRD); the Asian Bond Market Initiative (ABMI); the research group to further financial cooperation and stability in the region; the monitoring of short-term capital flows; and the Chiang Mai Initiative.

Cooperation among East Asian countries also continues in various other regional and global fora in which these countries are members, i.e. APEC and others.

Financial Engineering

Delivering his keynote address to the ‘Asian Economic Integration: Progress, Challenges and Opportunities’ Conference, held in Vancouver, Canada on 13 October 2005, the Special Advisor to the President, Masahiro Kawai, stated:

“The Asian governments have embarked on various initiatives for “institutional cooperation” to support market-driven economic integration. First, the region’s trade officials have been putting significant efforts to forge closer ties through free trade agreements (FTAs) or economic partnership agreements (EPAs). Second, the region’s finance officials have initiated monetary and financial cooperation through the Chiang Mai Initiative, regional economic surveillance and Asian bond market development. Third, infrastructure officials have been working together to construct cross-border infrastructure with regulatory coordination. Fourth, the region’s Heads of States have announced their intention to create an “East Asian Community” and to hold the first “East Asia Summit” meeting in Kuala Lumpur in December this year.”

And then he added:

“Multinational corporations have set up regional production networks and supply chains by locating different sub-processes in different countries based on comparative advantage-relative factor proportions and technological capabilities. This strategy has stimulated vertical intra-industry trade in industrial materials, parts, components, semi-finished and finished products within East Asia, thereby making East Asia a self-contained production base for the world.

Market-driven financial integration has also been underway as a result of the increased deregulation of the financial system, opening of financial services to foreign institutions, and liberalization of the capital account in Asia.”

The importance of overcoming all these challenges is, according to some experts, clear. However, other experts maintain that the hardest challenge of them all is to create the necessary financial resources to allow these other processes to come into being and keep on developing. These practitioners of Islamic Finance are, therefore, aware of the difficulties and time involved in preparing and appropriately implementing Sukuk to finance infrastructure development projects.

Indeed, it is quite likely that they have been practicing financial engineering. Such a multi-disciplinary field comprises design, development, and implementation of innovative financial products and of financial processes in the major market segments of currency, interest rates, equities, and commodities, for training, investment, hedging, and risk management. Within this cross-disciplinary field, finance considers returns, risks and transactions costs, economics brings into focus aspects of equilibrium and preference optimization under incomplete markets.

As the Asian Development Bank’s Regional Technical Assistance Report for Bond Financing for Infrastructure Projects in the ASEAN+3 Region indicated, considering the implications of the Asian Financial Crisis, it is possible to identify the need for financial engineering in general and for the appropriate financing of infrastructure projects in particular.

The lack of well-developed local currency bond markets was one of the causes of the 1997 Asian Financial Crisis. At that time, overdependence on bank financing forced borrowers to take on excessive short-term foreign exchange exposure to finance long-term projects that could generate only local currency revenue, resulting in mismatches with respect to both loan maturity and exchange rates. When international confidence in one local currency caused a rapid depreciation against the United States (US) dollar, a payment crisis ensued, exacerbating a loss of confidence across the region (the “contagion” effect). This led to a banking and currency crisis in several countries. Structural reforms were implemented throughout the region, and most crisis-affected economies have recovered and returned to robust growth. However, the absence of alternative sources of long-term local-currency financing and the region’s lack of efficient bond market continue to be a source of potential financial vulnerability.

The Association of Southeast Asian nations (ASEAN) + 3 Finance Ministers established the Asian Bond Markets Initiative (ABMI) in August 2003 to boost development of local currency bond markets to help mitigate the double mismatch problem, and channel Asian savings to the region.

In March 2007, at the ASEAN+3 Finance Ministers’ Meeting in Japan, the ABMI Working Group on Creating New Securitized Debt Instruments requested ADB to undertake a study on financing infrastructure projects with bond issues, particularly ASEAN+3 local currency bonds, and to identify available or possible debt instruments for financing domestic and cross-border infrastructure projects in the region. The concept paper was approved by the ADB and it is now being carried out.

A major priority for ASEAN+3 is finding a way to finance the region’s massive infrastructure demand. As previously discussed, estimates vary.

Given the globalization of financial markets and the growing array of sophisticated instruments available, infrastructure finance can now include a mix of local and international funding (e.g. syndicated bank loans, structured finance equipment leasing, bonds, and Islamic Sukuk).

The reasons why private investment in East Asian infrastructure picked up in the 1990s are the severe resource constraints, starting with the new millennium, which made financing needed infrastructure a huge challenge for most of ASEAN+3, inefficient pricing policies, ineffective delivery systems, and inconsistent regulatory frameworks (bankruptcy proceedings and bureaucratic inefficiencies). From 2001 to 2006, East Asia and the Pacific accounted for about 18% of total private investment in infrastructure in all developing countries, down from 27% for 1990-2000. This was despite consistently strong economic growth as the region recovered from the Asian Financial Crisis.

There are various types of bonds (government bonds, corporate bonds, revenue bonds and project bonds) that can be issued to finance infrastructure projects. Infrastructure bonds can be a more efficient form of financing as it meets the long nature of infrastructure financing which is often not available from the banking system. It also brings more transparency to the transaction and the financial market as a whole. To convince the private sector to increase its participation in infrastructure financing, ASEAN+3 governments need:

  • To continue financial market reforms;
  • To foster an investment environment conducive to private contractual activities to develop an efficient market for infrastructure bond financing;
  • To re-examine contractual, political, and regulatory risks and investor protection provisions;
  • To re-consider adequate measures adopted to stimulate local regional and international investment in infrastructure bonds;
  • To tap regional bond markets – given the considerable savings and accumulated foreign exchange reserves available in the region – for long-term infrastructure investment;
  • To take into due account that regional bond markets face several constraints including their size, relative liquidity, and regulatory environments, and these do not foster investment confidence;
  • Investments in infrastructure bonds can be discouraged by the lack of adequate investor protection measures and poor enforcement of securities laws by regulators.

Improvements in the creditworthiness of potential bond issuers will be needed to attract local, government and international investors. The recent turbulence in the credit market requires improving the transparency of the rating process for structured transactions.

The size of the infrastructure financing gap for the ASEAN+3 region highlights the need for cooperative efforts to bring new sources of capital into the region. ASEAN+3 member countries need to work together to find effective financing mechanisms to stimulate infrastructure project investment. This would be more efficient than individual countries seeking to independently access the limited available funds to finance their own infrastructure needs. Thus, the importance of Islamic Finance.

Sukuk, we mentioned earlier on, are Shariah-compliant and tradable asset-backed, medium-term notes, which have been issued internationally by governments, quasi-sovereign agencies, and corporations after their legitimization by the ruling of the Fiqh Academy of the Organization of the Islamic Conference. Over the last five years, the Sukuk has evolved as a viable form of capital-market-based Islamic structure finance, which reconciles the concept of securization and principles of the Shariah law on the provision and use of financial products and services in a risk-mitigation structure subject to competitive pricing. The Accounting and Auditing Organization of Islamic Finance Institutions (AAOIFI) currently recognizes 14 different types of Sukuk, which are traded on the Scripless Securities Trading System (SSTS) in Malaysia.

Sukuk has indeed developed as one of the most significant mechanisms for raising finance in the international capital markets through Islamic-acceptable structures. Table No.7 shows growth in Sukuk issuance from 2000 till 2007.


YEAR 2000 2001 2002 2003           2004     2005      2006       2007
Corporate Sukuk 33.6.3 530 179.9 4537.06            5731.19       11358.89  24526.32
Sovereign Sukuk 0 250 800 1180                 1479.35       706.5         2271.6
Total issuance Sukuk 336.3 780 979.9 5717.06    7210.54   12065.39 26797.92
Percentage growth 131.94 25.63 483.43                26.12          67.33              122.11

Source IFIS

With project finance transactions reaching record highs and infrastructure development requirements assessed at the level previously mentioned, demand for large-scale projects across the water, power, petrochemicals and other sectors is growing at an exciting pace. Combined with the huge boom in major real estate projects, the stage is set for meeting the challenges of financing complex projects.

However, experts have noticed that what is making the market even more dynamic and exciting is the increasing role that Islamic-structured transactions are playing in infrastructure finance and this is having the knock-on effect of spurring more innovative “next-generation” Islamic Finance solutions. Table No. 8  illustrates how expansion and innovation have developed through the years.


2005 volume of issuance: 55 issues raising US$9.6 billion 2005: 11 issues raising US$2.3 billion
2006 volume of issuance: 66 issues raising US$17 billion 2006:  17 issues raising US$6.4 billion
2007 volume of issuance: 40 issues totaling US$33.8 billion 2007:  raised US$50 billion


United Arab Emirates 4,945.90 6
Saudi Arabia 600.00 1
Malaysia 5,858.17 35
Kuwait 200.00 1
Pakistan 16.48 1
Bahrain 101.00 7

Source: Islamic Finance Information Service (IFIS)

Sukuk is the fastest growing segment, with global volume reaching US$97.3 billion in 2007. More than 95 per cent of Sukuk issued in the Asia Pacific is issued by Malaysia.

According to Moody’s, overall Sukuk issuance should continue to increase by around 30-35 per cent a year. Asian-currency-denominated Sukuk outstandings grew by close to 50 per cent, from US$43.6 billion in 2006 to US$65.3 billion in 2007. And, despite the financial market meltdown in the aftermath of the US sub-prime crisis from the middle of 2007, Sukuk issuance continued in the second half of the year. Notwithstanding the global credit crunch, Asian-currency-denominated Sukuk issuance rose 27 per cent from July to end of December 2007.

In 2007, Malaysia had the largest domestic Islamic Banking market in the world. Ringgit-denominated Sukuk issued in 2007 was equivalent to US$64.4 billion, representing 66 per cent of global outstandings as of 31 December 2007.

The Islamic bond, or Sukuk, we have seen is fast rising in popularity and so lucrative is the potential market that conventional international banks are falling over themselves to set up Shariah-compliant operations. With abundant oil-windfall revenues and a raft of infrastructure mega projects either underway or on the drawing board, the Gulf is fast becoming the logical choice for new and established players alike to set up shop.

But why in the first place would an investor buy Sukuk rather than normal conventional bonds?

Experts argue that the answer lies, putting Islamic motive aside, partly because investment in Sukuk gives some sort of relief to investors when it is said that Sukuk are less volatile as compared to conventional bonds, since they are basically asset-backed and not just a mere securitization of future cash flow in the form of debts payable in future as practiced in conventional securitization.

In Sukuk, when an investor purchases the certificates, he in fact purchases an undivided share or interest in the underlying assets that back the Sukuk issuance. In order to comply with Shariah

Requirements these assets must be essentially tangible assets, and the position of the investor must be one of a full owner throughout the tenure of the Sukuk. Ownership in this contact must means full ownership as understood in Shariah Law that confers all rights and privileges to the relevant owner who, on his part, is entitled to receive whatever income that can be generated by the asset, including a possible rise in its value.

There is geopolitical upside to the proliferation. It gives people the chance to learn something positive about Islam, and it counters negative issues in other areas. Furthermore, cross-border sales of Sukuk are prompting greater harmonization in the way the bonds are structured.

And there is also the fact that infrastructure is a perfect use of Sukuk because you are raising funds that are to be used for a specific project. Assets that you create can generate a return to pay bondholders.

The Deputy Governor of Bank Negara (Central Bank of Malaysia), Dato’ Mohd Razif Abd Kadir, interviewed by the Business Digest of the European Union-Malaysia Chamber of Commerce and Industry stated in the 3 July 2008 issue:

“Meanwhile, 66% of outstanding Sukuk in the global market originated from Malaysia – the outstanding value being US$97.3 billion as at the end of 2007. And the Sukuk market has overtaken the size of the conventional bond market, accounting for 56% of total outstanding bonds in Malaysia. The country’s bond market as a whole is already the largest in ASEAN, and in terms of percentage of GDP, it is the third highest in Asia.

“The first company that used Sukuk to raise funds in the world was Shell in 1990. It raised RM125 million through this program. Sarawak Shell subsequently did a bigger issue of ROM560 million. In 2003, Nestle Foods Sdn Bhd issued RM700 million. Tesco stores raised RM700 million last year. These are some examples of European-owned companies who have used Sukuk to raise funds. Another success story is the Binariang GSM (Maxis Communications) Ringgit issue of ROM15.35 billion Sukuk, which was oversubscribed by two times despite the peak of subprime problems in December. It is the largest ever Sukuk in the world, and was the largest corporate issue ex-Japan. For US$ issue, the Khazanah issue of US$850 million in 2007 was 13 times oversubscribed by investors from Europe, the Middle East and Asia. This year, Khazanah had another issue (US$550 million), which was 10 times over-subscribed. This is an indication of the international appeal of Sukuk.”

With these previous experiences, the possibility of raising funds for satisfying infrastructure needs in East Asia can become a reality.

Learning from the East?

Since, in the course of this analysis, we have stated, among other things, that Islamic Finance:

  • is an integral part of the overall financial system;
  • becomes increasingly more internationally-integrated;
  • demands continuous efforts to innovate;
  • is bound to the promotion of international strategic alliances to create synergies able to bring about new approaches, new technologies and new areas of specialization;
  • experiences a critical shortage of talent;
  • is aware of the progressive convergence of Shariah views and rulings, the mutual recognition  of financial standards and products across jurisdictions, and therefore they become major drivers towards greater international financial integration;
  • demands greater cooperation among the regulators to ensure that the Islamic financial system is not subject to vulnerabilities and abuses, thus ensuring its soundness;
  • co-exists with conventional banking;

the ultimate question to be asked is: should Western finance learn something from the East, i.e. Islamic Finance?

First of all, it should learn to co-exist with Islamic Finance, which has three major characteristics: it prohibits interest, it does not allow the undertaking or financing of anti-social or unethical businesses; it has to be compliant with the basic precepts of Shariah.

Secondly, it should acknowledge that there are several reasons why Islamic Finance services are spreading so fast in the West. There are around 15 million Muslims residing in non-Islamic countries in Europe, mostly in France, Germany and the UK. They were not benefiting from conventional banking on religious grounds and are now participating through IF in conformity with their beliefs. Second, there are investors who, in their quest for diversifying their portfolios, are looking for new asset classes, new instruments and new products with low correlation with the existing asset classes or products. Third, there is a growing trend to move away from unethical or socially irresponsible investment funds and businesses.

Thirdly, the West needs, therefore, to understand IF because it is necessary:

  • To implement one of its core values: freedom of religion;
  • To be open to learn from practices of the Muslim faith and modify its customary practices despite the fact that they are coming from secular cultures and market economies;
  • To bridge that gap of its knowledge with respect to banking and financial market practices of the East;
  • To understand, analyze, and have an action plan because Western secular, commercial and regulatory law developed in an environment where Islamic principles were unknown;
  • To appreciate forms and substance. Indeed, Western regulators are more interested in substance than in form while religious law tends to focus on form as well as substance.

Other things that the West may learn from IF is that IF requires Muslims to take part only in activities or ventures that are considered Halal. The Shariah represents an early form of socially responsible investing. Another reason: given that the West operates within market economies and that Muslims are a growing population within these economies, the needs to be served have to be understood. Finally, principles may be imported by the West because they may lead to an improvement in its institutions, especially in areas of ethics and transparency where the West has been challenged in recent years.

At the second Annual World Islamic Infrastructure Finance Conference 2007, the theme was ‘Innovations – a key factor in Islamic Finance towards the growth of the market’. The CEO of the Doha Bank, Mr R. Seetharaman, brought to light the challenges of Islamic Finance, namely need for increased business penetration, need for an effective business facilitator, need for improvements in trade cycle and processing time, need for standardized interpretations, need for high-end technology development, and better liquidity and maturity profile management. Furthermore, more innovations in terms of alternative solutions, like the use of derivatives, are required to be developed in compliance with Shariah principles.

This observation was very much in line with developments occurring in recent years in several countries in East Asia, most with large Muslim populations, which have developed Shariah-compliant products and markets. An example that symbolizes also the growth of the industry is Malaysia.

Indeed, Malaysia is at the forefront of Islamic Finance. It is the largest issuer of Islamic financial products in East Asia. In 2006, Islamic bonds accounted for nearly 25% of total local currency bonds outstanding. The Securities Commission of Malaysia supervises the Islamic Capital Market (ICM), which operates parallel to conventional capital markets. Malaysia is also host to the Islamic Financial Services Board (IFSB) which is, since 2003, the international-standard setting of regulatory and supervisory agencies to ensure the soundness and stability of Islamic Finance.

The Financing Gap

Table No.10  reminds us that according to studies carried out, the East’s infrastructure financing needs vary from a minimum of US$228 billion/year to a maximum of US$608 billion/year.


SOURCE AMOUNT (bn US$) Financing Gap Remarks
Asian Development Bank, Japan Bank for International Cooperation and World Bank (2000 prices)

228 (from 2007-2011)


Estimates are made on aggregate demand

ESCAP sectoral studies (2004 prices) 608 220 Estimates are made on sectoral demand

Source: Asian Development Bank, Japan Bank for International Cooperation, and World Bank: Connecting East Asia: A New Framework for Infrastructure, 2005 and ESCA estimates 2004.

From this analysis, it would seem that the East Asian region can expect a financing gap of a minimum of US$180 billion annually between demand for infrastructure investment (US$228 billion/) and supply (US$47.8 billion) from public and private sources. However, sources provided by multilateral institutions ADB, IBRD, and JBIC for infrastructure projects have averaged US$7.4 billion per year from 2000 to 2004. Estimates made independently by the Asia-Pacific Infrastructure Forum bring the region’s infrastructure investment requirements to US$300 billion per year. So, the question to be addressed is: how to bridge this financing gap?

A general belief is that openness to international capital flows, which ushers substantial foreign direct investment into many countries, would provide countries with the opportunity to make use of regional capital markets in particular and international markets in general to finance these infrastructure investment projects through regional financial intermediation. How to raise such a capital? By creating a special regional bank just to satisfy these infrastructure needs? Other alternatives?

Well, there could be several other options:

Þ     An expansion of the ADB and World Bank involvements in infrastructure;

Þ     Expanding the Asian Bond Fund to include most of Asia and the Pacific making its infrastructure finance-friendly;

Þ     Reinvigorating sub-regional bank projects that had been previously shelved, like the Northeast Asia Development Bank;

Þ     Setting up a new institution, such as the Asian Investment Bank, similar to the European Investment Bank, for cross-border financial intermediation. It could be quite effective in promoting infrastructure and related development by raising the necessary financing directly, as well as by catalyzing private investments.

Þ     Others?

The fact is that to deal with this gap, national governments and multilateral organizations must systematically access savings through domestic and international capital markets while developing public-private partnerships. Commitment at the political level, throughout the years, will be key to moving forward in that direction. Forming an intergovernmental committee/task force to further evaluate the options open and make recommendations on the way forward, to the politicians, could be the next step bringing to consider Islamic Finance and Sukuk. Such an alternative seems to be a winning strategy because of past experience in the East Asian region. Indeed, regional cooperation in developing infrastructure has followed a two-track approach: on the one hand, there has been cooperation in building cross-border infrastructure that exploits shared resources (such as energy and water), harmonizing cross-border rules and regulations and learning from good institutional practices and policies. On the other hand, there has been cooperation in financing infrastructure development.

For and Against the Motion

Reaching the end of the debate before this research, the motion is: Islamic Finance does significantly contribute to expedite the East Asia integration process. Is it approved? Is it Dis-approved?

Against the Motion

Throughout this research, the arguments made against the motion are as follows.

The Islamic capital market is subject to the same regulatory framework as the conventional market and needs to satisfy the same requirements for discourse, transparency and governance. Naturally, Islamic capital market products must also comply with Shariah requirements. It follows then that, considering:

  • The many different interpretations that many experts give to the Islamic Finance operation;
  • Harmonization of standards, mutual recognition of regimes, cross-border issuances, depository receipts and expansion of intermediaries through branch offices and alliances;
  • Cross-border investing can also occur through the introduction of regional Exchange Traded Funds;
  • Exchange alliance is just one means of enabling market integration;

and the cultural and environmental difficulties in carrying out each one of them, it would certainly seem to be appropriate to vote against the motion.

Furthermore, community building in Asia will involve – as Ambassador Henrik Schmiegelow noted in his paper ‘How “Asian” will Asia be in the 21st Century’ – a great deal of debate on how far it can rely on functional integration alone, on how much “brotherhood” and ethical communality it will need, on how much balance of power it can afford without becoming a dependent variable of global dynamics, on how nationalist resentments can be restrained.

In addition, the question is, can Islamic Finance’s meteoric rise really be amalgamated as an “Asian” phenomenon? Will it favor Asian integration or will it remain a mere aggregation of economic data hiding the fierce competition of nations attempting to catch up with, or overtake, other nations? In short, will Asians one day evaluate each other critically, in terms of how “Asian” their behavior is, in the way Europeans have learnt, the hard way, to be “good Europeans”? Any attempt to answer these questions must take into account impressive evidence of functional integration and regional community building. Great power rivalry in Asia is a problem; the balance of power politics is no panacea. Cultural commonalities are more important in Asia than meet the Western eye, but just like in the West, nationalism remains a divisive risk.

In the end, Asia may surprise the West by practising more consistently than America and American philosophy: the philosophy of pragmatism..

For The Motion

The analysis carried out throughout the three parts of this research has evidenced the following key factors to vote for the motion.

Sukuk is the fastest growing segment of Islamic Finance, with global volume reaching US$97.3 billion in 2007. More than 95 per cent of Sukuk issues in the Asia Pacific are issued in Malaysia. Indeed, in 2007, Malaysia had the largest domestic Islamic Banking market in the world, and is expected to expand by 30-35% in 2008, maintaining the momentum of the past two years.

The market for Sukuk is now maturing and there is an increasing momentum in the wake of interest from issuers to investors. Sukuk have confirmed their viability as an alternative means to mobilize medium long-term savings and investment from a huge investor base. There is also a growing awareness, interest and appetite for Sukuk among non-Muslims; governments are supportive, and Sukuk offer cultural flexibility, better asset/liability management as well as refinancing options.

Furthermore, there is geopolitical upside to the proliferation of Sukuk issues. It gives people the chance to learn something positive about Islam, and it counters negative issues in other areas. Sukuk offers the potential to mobilize funding for social capital markets, such as power and water, where consumers will be better able to pay later. However, the infrastructure is needed now. This could help reduce gap in the standard of living between the haves and the have-nots.

In order to divert some of the huge flow of Asian savings to Asian long-term investment rather than into US treasury bills or bonds, the Executives’ Meeting of the East Asia Pacific Central Banks launched a first “Asian Bond Fund” of US$1 billion in June 2003 and a second of US$2 billion in December 2004. To encourage the gradual establishment of a cross border Asian bond market, the ASEAN+3 Finance Ministers have taken the “Asian Bond Market Initiative” to help create the necessary clearing and settlement mechanisms.

In relation to market integration, greater cross-border investments will generally facilitate the pooling of liquidity and risks to improve the efficiency of capital allocation. More efficient capital allocation will promote faster economic growth. Capital market integration will also enhance the ability of the region to compete for capital and order flows while aligning national regulatory approaches will reduce the costs of operating in the regional market.

Integration of financial markets can occur through strategic alliances among exchanges. The European experience demonstrates that integration of exchanges is largely driven by market forces and is determined mainly by commercial considerations.

The integration of markets need not necessarily be bound by geography but rather by identity. The OIC Organization of Islamic Conference? member countries collectively form a substantial base that can be considered to logically offer a distinct Islamic “brand value” for both market-based intermediation and financing activities.

The integration of Islamic capital markets:

  • Can be accelerated through greater collaboration to promote the growth of markets throughout the OIC. Capital markets in the OIC are not sufficiently well-developed relative to its economic capacity and this means that there is substantial upside growth potential;
  • Has considerable potential to recycle excess savings from surplus OIC countries and to intermediate these surpluses to promote economic development in deficit member countries; which is consistent with the Shariah principle to ensure equitable allocation of capital;
  • As it advances, it will serve as a powerful catalyst for the future expansion of intra-regional trade and investment, creating a self-sustaining and mutually reinforcing economic growth in the region;
  • Will be able to leverage on the advantages of economics of scale, innovation and more importantly, place greater reliance on the cumulative strengths that reside within the region, including financial resources, skills and knowledge. It will also better position the region to collectively address emerging issues and challenges faced by the region taking into consideration the region’s socio-economic context.

The increased economic and financial linkages within the region spur further regional economic and regional financial integration. The geographical proximity and cultural similarities have been reinforced by the diverse strengths that exist in the region. These factors have been important in enhancing the integration process.

There are several ways to enhance financial inter-linkages: they expand beyond domestic borders, thus strengthening the regional economic linkages. The regional authorities and regulators have also come together to develop the regional financial markets, and others. These developments have paved the way for new forms of economic partnerships and strategic alliances and advance further the regional integration process and its inter-linkages with the rest of the world.

The restructuring, consolidation and reform of the financial sector have strengthened the capacity, flexibility and resilience of the financial system. In addition, the bond market and Islamic Finance have developed. Continuing to progressively liberalize its already open financial system to further enable free flow of funds into and out of the system, Malaysia has opened up, with this transformation, the potential for a range of new opportunities for participation in the financial sector and for facilitating greater financial flows within the region.

Asian economic integration is now already well advanced through the intensification of intra-regional trade and investment. Trade within Asia now accounts for more than half of the total trade of the region. This change is partly the result of the rapidly growing economies in Asia, which has created a large and expanding cumulative export market. This economic integration is also the result of Asia’s participation in the globalization of production. These trends have led to greater diversification of economic activity in the region and a reduction in the over-concentration in the traditional export markets.

Well-developed and integrated Islamic money, capital, and foreign exchange markets will not only be beneficial for borrowers and institutional investors but can also further enhance the stability of Islamic Financial Institutions, providing them with improved portfolio, liquidity and risk management tools.

As the Islamic financial system becomes increasingly more internationally integrated, it is important to recognize the different regional and institutional strengths and complementarities and the need to maximize synergies. Collaboration among regional centres and key players in Islamic Finance will be an important part of the process that will contribute towards greater international financial integration.

The Islamic financial industry in turn can reinforce and support globalization by bringing to it financial innovation and stability, provided it is properly nurtured and developed in conformity with the internationally well-accepted and tested financial sector prudential and regulatory frameworks.

The Deputy Governor of the Malaysia Central Bank explained, in the previously mentioned interview, that:

“The key factors that make Malaysia’s Islamic market attractive are essentially the creation of competitive products, critical mass demand, and a comprehensive regulatory framework in place. A factor that would accelerate its growth is the inflow of funds from Middle Eastern countries, driven by geopolitical factors and lucrative investment opportunities. It is estimated that the Asia Pacific has surpassed Europe as the second largest region for investment from members of the Gulf Cooperation Council (GCC). Islamic financial products are popular among investors because they are based on non-speculative or real underlying activities. Islamic products are accepted by Muslims and non-Muslims alike. Public Bank and Hong Leong, for example, are banks with mainly Chinese customers but their Islamic business is huge. The presence of ready buyers for Islamic instruments is a critical point in the success of the industry in Malaysia. The core demand comes from Islamic banks and Takaful operators as well as large funds like the Employee Provident Fund (EPF), Tabung Haji Fund, pension funds, and Islamic unit trust funds. Due to this critical mass of ready buyers, the issue can get a more competitive price on its issue – it can be 5-25 basis points cheaper than a conventional bond on the same credit risk.”

On the basis of these considerations, it would also be possible to vote in favour of the motion because Sukuk subscription for infrastructure projects in East Asia could really allow Islamic Finance to make a significant contribution on actually integrating the countries within the East Asian region.


The purpose of this study was to directly address the key question: Could Islamic Finance contribute to transforming the East Asian integration process from dream to reality?

In order to properly address it, we have dedicated:

Part I of this study to gaining an understanding of what Islamic Finance is, how and where it operates, when it started and what its future will be.

Part II to focusing on all the stakeholders’ perceptions involved in the Islamic Finance industry.

Part III to creating an overall view of the trends, requirements, history, momentum, and mechanisms/vehicles, which would make the integration process work within the context of the East Asia region.

Once this research has been able to supply the necessary inputs, we have spelled out the reasons argued for supporting the motion and those forcefully portrayed against the motion.

Now these reasons, pro and against the motion, have to be balanced by gaining an understanding of how experts in Islamic Finance reply to the motion under discussion. Once this step has been made, then we will express our opinion to finally leave the reader to formulate and express his/her own opinion on the motion.

The Islamic Finance Experts’ reply:

From a Monetary Authority

“The development of Islamic Finance in East/Southeast Asia would contribute to the broadening and deepening of the financial services/capital market development in the region. From one perspective, it can be viewed as the growth of a new asset class. From another, it would help capitalize new investor flows that could help spur the growth and development of the region.

“Whether or not Islamic Finance would help speed up regional integration would depend on a number of other considerations, including whether regional economies take decisive steps to address issues that currently inhibit cross-border trade in goods, services and financial services. On financial services, the key issue would be how best to facilitate a more harmonized operating environment in capital markets (currently fragmented) and greater financial services/capital account liberalization that spur cross-border market access and trading.”

From a European Bank in Malaysia

“The main ingredient in any regional integration, at least from an economic standpoint, is the use of a common currency. In any Islamic system, the preferred currency is gold. However, I don’t see any of the ASEAN countries agreeing to the use of gold and so there is the reliance on Islamic Banking as a tool for regional integration. Even if we were going to go on a conventional basis, it would be very difficult for ASEAN to agree on a single currency, at least for the next 10 years.

“Another point is about motivation. It is well-known that in Asia, only two countries (Malaysia and Indonesia) subscribe to Islamic Banking due to demand from their own people who need to have Shariah-compliant products as a matter of religious faith. Others, like Singapore/Japan/Hong Kong are in there for the oil money. You can already see this in the kind of product and target market that these countries have. They are not interested in serving the retail market. Once the oil dries up, interest in Islamic Banking will wane. So using Islamic Banking as a basis for regional integration is really weak.”

From a Malaysian Islamic Bank

“The response to the above (question) is affirmative. It is more so where there is a sizeable or reasonable population of Muslims, of which demand for Islamic Finance products and services would lead to development of such offerings, initially via joint development with leading regulators of Islamic Finance Institutions, i.e. Hong Kong Monetary Authority visiting Malaysia to gather info on Islamic Finance from Bank Negara, Securities Commission etc. followed by leading Islamic Financial Institutions in countries with developed or established Islamic Financial Foundations/Institutions venturing into neighbouring nations or economies to broaden their business horizons and also attracted by the joint development between respective financial regulators.

“The said perspective offers integration from both the public and private sectors, i.e. the regulators exchange rates in establishing or developing the Islamic Finance industry, encompassing deliberation on issues ranging from human capital (talent recruitment), legal (intermediation process) to taxes (flow of capital).

“Meanwhile, the platform provided offers integration in the private sector making it possible to offer business across respective borders, leading to the real flow of human capital (talent imports), besides the flow of capital and technology.

“Equally significant, the Islamic offerings established could lead to greater exposure to distinct culture that accompanies Islamic Finance and its community.”

From a Global Wealth Management Centre

“On the one hand it, Islamic Banking & Finance (IB&F) could facilitate the regional Asian integration that ASEAN would like to see speed up through such IB&F initiatives as:

i) Malaysia recently assisting to establish an Islamic bank across the border in the Southern troubled region of Thailand;

ii) Japan, seeking to introduce IB&F into their domestic market, and for the Japan Bank of International Cooperation (JBIC) to issue Sukuk bonds through either Malaysia or Singapore;

iii) due to minority populations in parts of China & India, both have become members of the IFSB;

iv) but it is unlikely that IB&F can “speed” up this integration, as for example, in the case of Indonesia, the largest Muslim population in the world, is also the sleeping giant in the revivalism of IB&F, as past regimes due to socio-economic reasons, did not allow an Islamic state to develop for fear of its challenging their own political (military) regimes;

v) unless an initiative such as the US Ambassador to APEC (Patricia Haslach) being able to introduce at the next regional meeting in 2009 in (I think) Singapore, on the Ministers agenda for regional regulatory co-ordination, as part of the freeing up of cross-border challenges of trade, each jurisdiction will develop independently of the other;

vi) each jurisdiction has a different legal system, ranging from English Common Law in secular Singapore and Hong Kong to parallel or dual Islamic/English Common Law as in the cases of Malaysia & Brunei.”

From the Securities Commission

“Yes, I believe Islamic Finance can indeed facilitate the regional integration of East and Southeast Asia. The region has a large Muslim population, which has a desire to invest their savings in Shariah-compliant financial products. Similarly, the level of entrepreneurship among the Muslim communities can be raised through increasing the level of financing made available through Shariah-compliant approaches. Thus, the first objective must be to increase the level of intermediation that can facilitate economic development of Muslim communities, which in turn can lead to further demand for Shariah-compliant products from across the region.

“Increasing prosperity among the Muslim communities in the region will contribute to growing trade in goods and services amongst various parts of the region. This can be supported by efficient intermediation of the previously isolated pools of Islamic savings. Adopting an open architecture for Islamic Finance, where it operates on global standards and as a competitive and ethical approach to financing, will further increase the level of intermediation activities and promote greater cross-border capital flows throughout the region.”

From the Head of an Islamic Finance Window in an international Bank

“In my opinion, Islamic Finance can help the East Asia integration process because:

1.Malaysia as an Islamic hub can be a focus for East Asia Islamic transaction.

2.These East Asian countries can come and seek guidance from Malaysia on Islamic Finance that can only strengthen the relationship between these two countries and the region.”

November 2010

Prof.Dr. Corrado G.M.Letta who is Senior Advisor to The National Congress of Peru is a Op-ed contributor to the 4th Media

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