Plagiarism statement

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Plagiarism Statement

The School of Business Studies views cases of plagiarism or collusion by students very seriously. Any students who intentionally plagiarise or collude in any part of their assignments/projects or written work, threatens the values of academic work and undermines the credibility and integrity of the College's awards. Plagiarism or collusion discovered at any stage of the student's course of study will be dealt with appropriately by the School. Such offenders shall appear before a panel of enquiry at the School and appropriate punishment will be meted out. Punishment may include failing the student for the assignment or project, re-submission of another piece of work or downgrading of the work to the maximum of a pass grade even if actual grade achieved was higher.

What constitutes “Plagiarism” and “Collusion”?

Plagiarism according to the Oxford Advanced Learner's Dictionary of Current English means “take and use somebody else's ideas, words, etc as if they were one's own ”.

Plagiarism

can take the form of reproduction without acknowledgement from published or unpublished works of others including materials downloaded from computer files and the Internet.

Students' work submitted for assessment is accepted on the understanding that it is the students' own effort without falsification of any kind. Acknowledgement to the source must be made if students had relied on any sources for information with appropriate reference being made in their work.

Collusion

can be deemed to be a form of plagiarism involving the unauthorized co-operation between two or more people with deceptive intention.

Collusion can take the form of two or more students producing a piece of work together but with one intentionally passing it off as his work with the knowledge of the others.

Student may have submitted the work of another as his own with consent from that other student. In such cases, both parties are guilty of collusion.

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Students are expected to familiarize themselves with or make use of method(s) of citing other people's work in accordance with acceptable referencing.

School of Business Studies

Plagiarism Statement

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Table of Contents

Report 1

1.0 Executive summary

2.0 Global financial crisis- Background

3.0 Steps taken by the Malaysian government

4.0 Impact of the global financial crisis

Report 2

1.0 Executive Summary

2.0 Introduction to financial and capital markets

3.0 Development of the financial and capital market in Malaysia

4.0 Take-up rates

5.0 Summary of findings

6.0 Conclusion

References

Appendix

Part A

Write a report on how the current Global Financial Crisis impacted the financial strategies of Malaysian a Malaysian company. The report should include the background of the Global Financial Crisis, steps taken by governments to mitigate it and how it may have impacted the financial strategies of a chosen Malaysian company.

1.0 Executive summary

The global financial crisis has been one of the worst to ever hit the developed and developing nations since the Great Depression, and has quickly burgeoned into a global economic crisis. This report gives an overview of the crisis, and how it has impacted our nation.

Steps have been taken by the government to mitigate this crisis. This has been done through two economic stimulus packages meant to inject funds into the Malaysian economy to produce a multiplier effect for boosting the economy.

We then take a look at the effects of the sector on Gamuda Berhad, a company in the construction and property development sector. We see how the economic stimulus package has benefitted it through the granting of the Electrified Double Tracking Project from Ipoh to Padang Besar worth RM12.5 billion, and its effect on the company's financial strategies.

As steel is a major raw material in the construction of buildings and infrastructure, we also analyze the impact on the financial strategies of a steel company in Malaysia, Choo Bee Metal Industries Berhad. The report ends with a future outlook of the following two companies in the near future.

2.0 Global financial crisis- Background

Plummeting stock markets have wiped out 33% of the value of companies, $14.5 trillion.

The effects of the global financial crisis have been such that a massive $14.5 trillion in the value of companies has vanished into the thin air in a matter of months. It has been the most serious financial crisis since the Great Depression of 1929, causing business failures, increased unemployment, and significant decline in economic activity. What happened?

August 2007 had seen the world economy plunged into intensive financial disorder and turmoil. Fannie Mac and Freddie Mac, the two largest mortgage companies in the US fell into conservatorship. A week later, Lehman Brothers went bankrupt when the US government refused to rescue the investment bank, triggering the financial crisis.

Banks became reluctant to lend to one another, allowing only overnight borrowing to institutions. With banks refusing to provide credit, and the imposition of more stringent regulations on borrowings, businesses found it more and more difficult to borrow money for their operations and long-term expansionary plans.

In Iceland, the banking system crippled and the government had to borrow from the IMF and other neighbors for funds to save their economy. The country could not pay back its external debts, and the Icelandic currency- the Krona has become valueless. Virtually bankrupt, the three largest banks in Iceland: Kaupthing Bank, Landsbanki and Glitner Bank has been nationalized.

Insurance giant, AIG had to be rescued by the US government by the approval of an $85 billion bailout to prevent it from going under because it was “too big to fail”. All the above events accumulated to signal the lack of confidence in the US economy, plunging stock prices downwards, weakening the economy which quickly affected the economies of other countries due in part to globalization through increased connectivity.

The reason for the financial crisis cannot be pinpointed to any one specific cause, but is a result of a combination of factors which converge to tip the scale to cause a major change. However, the main cause for the crisis can be said to be attributed to sub-prime mortgage lending in the US. Simply, the appreciation of property prices coupled with easy credit offered by banks on the acquisition of property attracted people to purchase property, not only for personal but for investment purposes. Banks creatively pooled these loans into mortgage-backed securities and sold them off as derivatives to other investors. This is also known as the securitization of debt.

In order to encourage more customers to obtain loans from banks, the banks approved loans even to sub-prime buyers. These buyers have shaky financial background, but were also approved by the banks. With the burst of the US housing bubble, declines in real housing prices and higher mortgage rates eventually resulted in defaults in payments, leading to foreclosures and the collapse of the sub-prime mortgage industry. This then lead to the fall of several prominent financial institutions, sending shock waves around the world. The financial system became dysfunctional and this marks the commencement of a financial crisis.

To date, the UK and other European countries have spent some $2 trillion on rescues and bailout packages to prevent various major financial institutions from failing. Among other effects of the crisis are lesser financing and foreign aid for development in poorer countries. The economy is said by analysts to enter into global rebound and recovery in year 2010.

3.0 Steps taken by the Malaysian government to mitigate the financial crisis:

It is a well-known saying that, “If the United States sneezes, the rest of the world catches a cold.” This is true to a certain extent. Developed countries such as the United Kingdom and Europe were among the first to be hit by the effects of US “flu”. Developing countries such as Malaysia caught on slower, not having entirely opened up its economy to the rest of the world. However, effects were being felt. Deterioration in US market, being a major trading partner of Malaysia (3rd largest trading partner) eventually affected our country's economy.

Among the impact of the global economic recession are:

  • Sharp decline in exports (e.g. Jan ‘09 down by 27.8%)
  • Sharp decline in export commodity prices (crude oil and palm oil)
  • FDI inflows expected to halve ('09: RM26bln, '08: RM51bln)
  • Unemployment rate to rise to 4.5% ('08: 3.7%)
  • Global meltdown continues to weaken Bursa Malaysia's performance

This eventually prompted a response from the Malaysian government.

On the 4th of November 2008, the first economic stimulus package of RM7 billion was approved in order to boost the Malaysian economy. This was mainly financed through savings from fuel subsidies, which has decreased due to lower oil prices. This package was primarily directed at certain major projects mainly in the construction industry and was hoped to start off a positive ripple through the multiplier effect.

It was found to be ineffective when economic conditions worsened, and a second stimulus package was proposed. A further RM60 billion was pumped into the economy. Of this amount, RM15 billion is fiscal injection, RM25 billion Guarantee Funds, RM10 billion equity investments, RM7 billion private finance initiative (PFI) and off-budget projects, as well as RM3 billion worth of tax incentives. This RM60 billion accounts for almost 9% of the Malaysian GDP.

The implementation of such a large stimulus package is unprecedented in the nation's economic history. Training and job placement opportunities were initiated in both the public and private sectors to ensure acceptable unemployment rates. In addition, it is aimed at facilitating private sector activities and easing the burden of vulnerable groups.

The 2nd stimulus package is to be implemented in four thrusts:

RM

  • Thrust 1: Training, education, employment creation, retrenched 2 billion

    workers welfare & reduction of foreign workers

  • Thrust 2: Home ownership, public infrastructure, savings bonds, 10 billion

    school facilities, rural areas amenities, Sabah & Sarawak

    infrastructure, microcredit schemes, retrenched workers welfare

  • Thrust 3: Guarantee scheme (working capital & loan restructuring), 29 billion

    promote automotive, aviation & tourism sectors, higher windfall

    profit levy threshold on palm oil, tax incentives (accelerated capital

    allowance, carry back losses) and reducing time-to-market to access

    of the capital market

    telecommunication infrastructure, PFI (Tanjung Agas industrial park

    in ECER, biotechnology cluster in IDR, traffic infrastructure system

    around KL Sentral), enhancing GLCs' CSR activities in human

    capital, new FIC role & enhancing Government procurement

    Aware that most SMEs have been affected by the worsening global economic environment, particularly from the contraction in export markets, the Government has established a Working Capital Guarantee Scheme totalling RM5billion to provide working capital to companies with shareholder equity below RM20 million.

    In the Bank Negara Malaysia (BNM), the Overnight Policy Rate (OPR), which determines banks' base lending rate, has been reduced by 75 and 50 basis points to 2% in Jan and Feb respectively, and resulted in the lowered base lending rate of 5.53%. This is to encourage lending between banks. The statutory reserve requirement has also been cut by 3%-1% to help reduce the cost of funds and sustain the flow of lending.

    Among other initiatives taken by the government are: the guarantee of bank deposits until the end of 2010 by the BNM. What is more, to encourage foreign direct investments, Bumiputera ownership in the acquisition of equity stakes, mergers, and takeovers has also been lifted. Guidelines on property transactions has also been relaxed, and Danajamin had also been set up by the government in May 2009 to facilitate capital-raising by local companies who face problems in doing so.

    4.0 Impact of the global financial crisis:

    Sector: Construction

    I have chosen the company, Gamuda Bhd as the subject of analysis for this purpose. First, a brief introduction on the business of Gamuda, the company situation before and after the crisis, and its potential effects on the company's financial strategies.

    4.1 Gamuda Berhad

    Gamuda is among the largest builders in Malaysia, second only to IJM Corporation. Among Gamuda's other competitors are WCT Berhad and Malaysian Resource Corporation Berhad, all of which have been affected by the crisis.

    Gamuda is a leader in Build-Operate-Transfer (BOT) civil engineering infrastructure and township development. The core business segments in Gamuda are three: Engineering & Construction, Infrastructure Concessions, and Township Developments

    Percentage-wise, the Engineering & Construction is the most important sector as it takes up 75.9% of total revenue. Among projects included in this sector are the constructions of railway tracks, hydroelectric dams, airports, waterways and tunnels, etc. Infrastructure Concessions- 19.6% include: highway toll concessions, water supply, and hydropower. Township Developments- 4.4% include: various townships in Malaysia- Valencia, Jade Hills, Kota Kemuning, Bandar Botanic, the Yen So Park in Vietnam,

    4.1.1 Industry Overview

    The property and construction industry are capital-intensive sectors requiring sophisticated technologies, high levels of labour and manpower, and large amounts of raw materials such as iron, steel, and cement. These three inputs make up most of the costs in any given project, and an increase in the following costs would decrease profit margins and therefore returns from the projects.

    Due to the large amounts of money invested in a project (larger projects involves billions of dollars exchanging hands), cashflow management and cash conservation is crucial. Risks involved are also high, and investors expect higher returns and consistent dividends compared to a more stable sector such as food and beverages. A project has to ensure stringent safety and health policies, to minimize hazards and prevent accidents from occurring.

    At the strategic level, a company dealing in these industries would also have to be proactive in scouting for projects where opportunities exist. Detailed cost-benefit analysis will have to be undertaken not only to determine quantitative costs and benefits in calculating how much to bid for, but also qualitative factors such as the necessity and urgency of the project to the company, whether as a strategic move into new markets, reputation/brand building, or to increase confidence in the company and ease shareholder concerns.

    To sum it up, these sectors are susceptible to:

    - Rise in inflation

    - Increase in prices of iron, steel, and cement

    - Cancellation of orders due to economic downturn

    - A country's political influence

    - Cashflow management
    However the two real key risks faced by the construction industry remains to be delays in implementation and sub-par margins due to stiff competition.

    4.1.2 Property and Construction

    The property and construction sectors are sensitive to economic conditions. Thus it is no surprise that companies dealing in the two sectors were the most badly hit when the market plunged, following the onset of the global economic crisis. As Gamuda's operations in these 2 sectors consist of 95.5% in 2008, this makes it extremely susceptible to economic risk.

    We can evaluate the impact of the crisis by the construction sector's key performance indicators:

    àNumber of sales permit: Falling since July 2008, but the figures have reflected the pessimism of the industry distinctly since August 2008. Earlier in the year, it has reached 87 per month, fell to 58 in August and 41 in December 2008.

    àNumber of housing approvals: On the downtrend.

    àProduction of construction-related products: In September 2008, there was a 6.8% increase (year-on-year) in this index. It fell by 1.9% in October 2008, but most alarmingly there was a contraction of 5.1% in November 2008. This change shows the bleak outlook of the industry.

    4.1.3 Government steps

    The Government of Malaysia has benefited Gamuda after it won the bid for the Ipoh-Padang Besar electrified double-tracking railway project (EDTP) worth RM12.5 billion as part of the stimulus package to boost the economy. Among other projects by the government are the Pahang-Selangor Interstate water transfer project, the new Sepang low-cost carrier terminal, and the extension of the Klang Valley Light Rail Transit, all three contracts of which have been bid for by Gamuda. As a major construction company with an excellent track record, there is a high chance of winning the bid, hence increasing its construction order book by several billion dollars.

    In addition to that, the Government has also implemented a new `Deferred Payment'

    mechanism, where Bank Pembangunan has been mandated to pay on behalf of the government up to a total of RM6.75bn representing 54% of the total value of the EDTP project.

    As for the property sector, the Government is allowing individuals or foreign entities to buy commercial real estate worth RM500,000 and above without any Foreign Investment Committee (FIC) Approval. This move would encourage more buyers to buy properties here in the country and help encourage investment in real estate.

    4.1.4 Ratio Analysis- Highlights:

    The following can be seen from Gamuda's financial ratios:

    - Gamuda's ROA has increased from 3.32% in 2007 to 5.58% in 2008, signifying increased efficiency in the use of its assets in generating profits.

    - Gearing ratio remains at high levels, increasing slightly from 41.9%-43.5%.

    - Net dividends per share decreased from 40sen/share in 2007 to 18sen/share in 2008. Profits were retained to fund operations and projects obtained by the company.

    Other than the high gearing ratio, other financial aspects in 2008 are favourable overall.

    4.1.5 Capital structure

    Gamuda's capital structure consists of a combination of debt instruments and RM2,005,016 worth of shares.

    Long-term borrowings consist mostly of Murabahah Medium-term Notes (MTN) of RM850 million, and a smaller portion of secured and unsecured term loans.

    Short-term borrowings include commercial papers of RM35million, unsecured term loans of 25million, and revolving credits of RM722,253 million.

    There is a debt-equity ratio of 60% compared to 42% in the previous year.

    Thanks to the RM12.5 billion Ipoh-Padang Besar rail project won by Gamuda through the stimulus package, this has benefited Gamuda and boosted its order book. Hence the impact of the crisis on Gamuda is largely cushioned compared to its competitors. Revolving credits of RM 288.5 million is used in relation to design, construction, testing, commissioning and maintenance of the electrified double track.

    There is an existing proposal that Lingkaran Trans Kota Holdings Bhd (LITRAK), of which Gamuda is a substantial shareholder- owning 44.8% of LITRAK undergo a capital repayment exercise of 93 sen, of which Gamuda will receive an amount of RM462 million. The Selangor government also offered to take over Splash for RM2.975billion, both of which will improve Gamuda's net gearing.

    4.2 Steel

    Steel is a major raw material in the construction industry. Therefore we will now take a look at the impact of the financial crisis on the steel industry.

    Steel is a major raw material in the construction sector for the building of its properties and infrastructure. We shall now study Choo Bee Metal Industries Berhad to gauge the effects of government economic stimulation in this industry.

    The global economic crisis has had a major negative impact, on the international and domestic demand for Hot Rolled Coil (“HRC”) steel sheets, which is the main export of Choo Bee.

    The strong demand for steel, and high steel prices, in the early part of 2008 were reversed by the global financial crisis from September 2008. Prices of steel and steel products dropped rapidly on falling demand. Prices increased from US$700 per tonne in June 2007, to US$1,100 per tonne by June 2008, and collapsing even lower in 2009. This has affected the sales of Choo Bee, as the price at which its HRC can be sold has dropped sharply.

    Government efforts to improve the economy through its economic stimulus packages has benefited the construction industry, and has indirectly created opportunities for local steel manufacturers like Choo Bee to supply their steel to the market. However, Choo Bee being a relatively smaller steel company could not match the giant steel companies like Malaysian Steel Works, Ann Joo Resources, and Southern Steel Bhd. Raw materials for projects received by construction companies would most likely be given to larger steel companies which could provide lower prices due to economies of scale.

    The government is also implementing a proposal where a reduction of import duties of raw materials of 10% in 2009 and another 5% every subsequent year, which is expected to reduce Choo Bee's costs of production. This however, would also not be of much help, due to the dropping steel prices.

    Choo Bee currently has a very low gearing ratio of only 2.75%, signifying that it is operating on a very conservative level. It also has very high levels of reserves and retained earnings which are not being in use effectively for generating profits to maximize shareholder wealth.

    5.0 Conclusion

    Future outlook:

    Gamuda Berhad

    Performance is likely to be weaker than 2008 amidst economic uncertainties in the construction and properties sector. Borrowings and gearing ratio is expected to be high. However, if Splash is successfully sold to the government at a reasonable price, the substantial amount of cash received can be used to fund operations, reducing its gearing ratio and allowing further loans to be obtained if necessary. As cashflow management becomes a primary focus, and financial prudence necessary, this would most likely result in a lower dividend of 25sen received by shareholders in 2008. The “Deferred payment” mechanism is also expected to help manage working capital more effectively.

    A more conservative strategy would be used of where the focus would be on surviving the economic meltdown. This entailed taking drastic measures to curb expenses, consolidate operations, streamline capex programs and defer expansion plans.

    With Gamuda's strong reputation and experience in the construction industry, coupled with a strong order book caused by the Government's economic stimulus package will probably last it for the next 2-3 years. It is expected to regain its performance once the global recession lifts in year 2010.

    Choo Bee Metal Industries

    Outlook in year 2009 is likely to be negative for Choo Bee and the steel industry in general. As the demand for steel is highly dependent on the performance of construction sector, it will determine the demand for steel. Since the overall outlook on the construction sector has weakened due to the financial crisis, this would mean demand for steel, hence lower profits.

    Although the projects mooted out by the government through the stimulus package will indirectly benefit the steel industry, the overall demand for steel will still be low, but is expected to pick up when the recession enters into recovery.

    Part B

    Write a report on the development of the capital/financial market in Malaysia and how with this development more financial products could be used by Malaysian companies to finance operation, expansion locally and in the international markets. The report should include the development of the conventional capital and Islamic capital market, the take-up rate of financial products such as sukuk zero-coupon bond by Malaysian companies and how it changes their choice of financing and capital structure.

    1.0 Executive Summary

    The financial and capital markets in Malaysia have been experiencing exponential growth during the past few decades, especially where the advancement of Islamic financial products is concerned.

    This report is meant to give an overview of the development of these markets in Malaysia, with a focus on financial products, such as the sukuk by Malaysian companies. Malaysia has been at the advent of Islamic financing, and much effort has been taken by the government to establish Malaysia as an Islamic financial hub. Steps taken, and an examination of the popularity and advantages of these Islamic products are explored.

    In order to discover the take-up rate of financial products, eight major companies from different sectors in Malaysia have been chosen for this analysis. They comprise companies ranging from the industrial sector to the food & beverage industry.

    Finally, a conclusion as to the popularity of Islamic products and the potential changes as to the way businesses choose to fund their operations.

    2.0 Introduction to financial and capital markets

    2.1 Financial markets

    A financial market is a mechanism that allows the trading of financial assets or securities. This includes mortgages on a house or lease on a car to securities that are traded on financial markets, termed marketable securities. The trading of commodities such as precious metals and agricultural goods are also a part of the financial markets.

    Financial markets primarily facilitate:

    • The raising of capital
    • The transfer of risk
    • International trade

    They can be said to consist of the following six categories:

    Money market, Capital market, Derivatives market, Foreign exchange market, Fixed income stock, Equity.

    2.2 Capital market

    The capital market, as mentioned above- is a type of financial market, which includes the stock and bond market.

    They function in two important ways:

    In the primary market- to provide new capital for businesses in the form of share issues and loans

    In the secondary market- to enable the exchange and trading of securities and bonds to other players

    3.0 Development of the financial and capital market in Malaysia

    In Malaysia, Government securities through issues of Malaysian Government Securities (MGS) account for the bulk of funds raised in the private sector. Private Debt Securities (PDS) are the main source of capital market funding for the private sector, with the equity market also providing a sizeable portion through rights issues and Initial Public Offerings (IPOs).

    Singapore, once being part of Malaysia, companies in these two countries was listed on both KLSE and the Stock Exchange of Singapore (SES) until the end of 1989. Since then, KLSE has taken various measures, including the introduction of computerized trading, a central depository, and efficient clearing and settlement systems, to develop market infrastructure. In addition, the regulatory framework has been reviewed to promote IPOs and equity investments by domestic and foreign investors.

    As a result, some big privatized companies (e.g., Telekom Malaysia Berhad and Tenaga Nasioni Berhad [TNB]) were listed on KLSE, making it one of the fastest-growing markets in the region in the mid-1990s. By the end of the 1980s, the primary market for Government bonds was relatively developed. The Government introduced the principal dealer system to develop the secondary market as well, and at the same time, an auction system for Government securities to promote fair pricing. Although the private debt securities (PDS) market had deepened when the first Cagamas bonds were issued in October 1987, it did not develop until the mid-1990s.

    The Government has introduced various measures to enhance market infrastructure and put in place an appropriate regulatory framework. These included the establishment of a credit rating agency (1990), guidelines on PDS issues (1992), tax exemption on interest income from PDS (1993), scripless trading for unlisted PDS (1996), an auction system for the PDS primary market (1996), and a bond information and dissemination system (1997). Despite Government efforts, a lack of benchmark yield curve hinders the development of the bond market.

    3.1 Developments of Islamic Finance

    Malaysia is one of the unique countries which operate a dual banking system where the Islamic banking system operates in parallel with the conventional system. Similar to conventional banks, all banking facilities such as deposit account, financing and other products and services are available at Islamic banks. An important milestone taken by the government in positioning Malaysia as an international Islamic financial hub was to bring forward the liberalization of its Islamic banking sector to 2004, three years ahead of the World Trade Organization's deadline.

    The development of the Islamic financial system in Malaysia started with the establishment of pilgrimage fund (Tabung Haji) in 1963 as the first Islamic savings institution. The idea was mooted out of the necessity to develop a mechanism to encourage the Muslims to save for their pilgrimage as the Malaysian Muslims in the past had resorted to various traditional means of saving and keeping their money for the sacred journey. After a few years of break, the first full-fledged Islamic bank was established in 1983 with the name Bank Islam Malaysia (Islamic Bank of Malaysia).

    Ten years later, Islamic money market has developed and considered was seen and this segment is one of the fastest growing segments in Islamic financial instrument. In order to internationalize the Islamic banking industry and making Malaysia as an Islamic financial hub, the Malaysian government started opening its market to international players in this field. It started by allowing international banks which operates Islamic product to open their branches in Malaysia- Al-Rajhi Banking and Investment Corporation, Kuwait Finance House and RUSD Bank-led consortium which includes Qatar Islamic Bank and Global Investment House.

    The creation of Islamic money market and capital market is another landmark development in the area of Islamic finance in Malaysia. A wide range of instruments has been developed to facilitate the effective management of liquidity and funding by the Islamic financial institutions. The money market effectively serves as a channel for the conduct of liquidity operations by Bank Negara Malaysia as part of its monetary policy. The Government of Malaysia has been very supportive in the development of Islamic Capital Market (ICM). In 2001, the Minister of Finance launched the Capital Market Master plan and one of the six strategic initiatives in the plan was to establish Malaysia as an international center for ICM activities.

    The rapid development of ICM started in 1990 when Shell MDS Sdn Bhd issued the country's first Islamic bond. In 1994, Malaysia's first full-fledged Islamic stock broking company, BIMB Securities Sdn, Bhd, was formed. With the increasing prospects for Islamic securities, the Securities Commission of Malaysia (SC) established the ICM Unit which comprises researchers trained in both Fiqh Muamalat and capital market practices to undertake research on product origination and ICM operations. The SAC introduced the first Shariah-approved securities, which was listed on the Kuala Lumpur Stock Exchange (now known as Bursa Malaysia) in June 1997.

    The development of the ICM intensified when the Malaysia Securities Exchange Berhad (now known as Bursa Malaysia Securities Berhad) launched the country's Islamic equity index, the KLSE Shariah Index, in 1999. The index includes all Main Board shares that are on the Shariah-approved securities list.

    The Government of Malaysia has announced its ten year master plan for financial sector which comprises of three stages of plan. The objective of the first phase which extended from 2001 to 2004 was to strengthen the operational and institutional infrastructure whereas phase two which stretches from 2005 to 2007 will focus on stimulating competition. The final stage that extends from 2008 to 2010 will mainly be geared towards progressive liberalization and effective infrastructure.

    3.2 Islamic Finance

    With the rapid development of the capital/financial markets due to Government initiatives, more and more financial products are available for use by Malaysian companies to finance their operations, whether locally or in the international markets. Conventionally, the issuances of stocks and bonds have been among the main sources of financing. However, with Malaysia spearheading the development of Islamic finance, there are now novel financing methods which were once unavailable to these companies. These Islamic products will therefore be the main focus of this assignment.

    There are several reasons why sukuk, which is a zero-coupon bond is a viable source of financing for Malaysia companies. Despite being an Islamic form of financing, they are becoming a global phenomenon, attracting more issuers from a larger pool of countries than ever before. According to a report by Standards & Poor's, the global sukuk market more than doubled in 2007 exceeding $60 billion and is set to hit the $100 billion mark in the next few years.

    The question is, why are Islamic products gaining such popularity-as a choice of financing for both Muslims and non-Muslims alike?

    First, a description of how Islamic finance differ from the conventional:

    Allah says:
    Those who devour usury will not stand except as stand one whom the Evil One by his touch hath driven to madness. That is because they say, trade is like usury; but God hath permitted trade and forbidden usury. Those who after receiving direction from their Lord, desist, shall be pardoned for the past; their case is for God (to judge); but those who repeat (the offence) are Companions of the Fire: they will abide therein (forever). [Sura 2:275].

    The core principle that underlying Islamic finance practice is to obey to Allah's command that mainly to avoid ‘riba' and all the injustice practices that prevails in conventional banking. Islamic teaching says that money itself has no intrinsic value, and forbids people from profiting by lending it, without accepting a level of risk - in other words, interest (known as "riba") cannot be charged.

    Firstly, Islam prohibits the exploitation on other's needs (charging of interest constitute exploitation).

    Secondly, there is no risk-free in Islamic business environment in Islam. This implies that the lender should share the risk of business.

    Therefore, Islamic financial products is crafted in a manner that no exchange of interest is involved, and is not tradable in a secondary market, but instead held to maturity or sold at par. Islamic finance today is led predominantly by sukuk bonds. 'Sukuk' means certificates. The criteria for issuance of sukuk are the existence of the underlying assets on the balance sheet of the issuing entity.

    Unlike the conventional bond, a sukuk holder enjoys proportionate share in revenue generated by the sukuk assets as well as in the proceeds of the realization of underlying assets. Because sukuk are backed by actual assets, it also limits the possibility of user default.

    There are various types of Islamic products: Murabaha (Profit - sharing), Musharakah (Joint ventures), Mudarabah (Financing), Ijarah (Renting), Istisnaa (Industrial - Financing), bia al salam, bai bitthamen ajil, etc (types of Islamic forwarding sells)

    In brief:Ijarah , synonymous with leasing, relates to the right to use or derive profits from assets and properties owned by a third party in exchange for rent. Istisnaa is a transaction in which the buyer places an order for goods to be manufactured. The price and commodity specifications are agreed on by both buyer and manufacturer. The price does not have to be paid in full in advance.Murabahah is a sale in which the seller discloses the actual cost of goods sold to the buyer and adds a profit. Payment may be on the spot or deferred. Salam is a sale whereby the seller undertakes to provide specific goods to the buyer at a future date in exchange for a price which is paid in full immediately. Though one company may be issuing a similar type of sukuk as another, the terms and conditions of the sukuk might not be the same. This is due to the diverse interpretations of the Holy Quran regarding the proper use of financing for businesses.

    4.0 Take-up rates

    For the purposes of determining the take-up rate of conventional and Islamic products, I will analyze the following eight companies from varying industries: Gamuda, F&N, Air Asia, Proton, Sime Darby, British American Tobacco, Berjaya, and Shell Malaysia.

    Gamuda Berhad

    Gamuda Berhad is a construction giant in Malaysia, dealing in the construction of various infrastructure and real estate.

    Forms of financing used in the company are term loans, 3% redeemable unsecured bonds, revolving credits, and commercial papers.

    The company has also been issuing Murabahah medium-term notes (MTN) since mid 2005. Before this time, operations were financed mostly through long-term loans. To finance its long-term borrowings, MTNs of RM480 million has been drawn during 2008, with tenure of 5 years at a weighted average of 4.8%. A drawndown of MTNs by a wholly-owned subsidiary-Harum Intisiari Sdn Bhd of RM200 million is made. MTNs worth RM70 million were drawndown by another wholly-owned subsidiary, Horizon Hills Development Sdn Bhd (HHDSB).

    82% (RM850million out of RM1.04billion) of Gamuda's long-term financing consist of MTNs. This show that sukuk is now a major part of the company's choice of long-term financing. Shareholder equity totals RM3.05 billion. Gearing ratio for Gamuda is at an acceptable 34%.

    AirAsia Berhad

    Air Asia is a low cost carrier in Malaysia, known as the world's best low cost airline in 2009. With over 110 routes across 13 countries, it is Asia's leading low cost airline with the widest route connectivity and largest customer base.

    The company is financed by a shareholders' equity of RM1.6 billion. Conventional financing used consist of term loans, revolving credit facilities, and finance leases. 80% of the AirAsia's long and short-term borrowings consist of term loans.

    The company uses two forms of Islamic financing:

    1. Finance lease liabilities (Ijarah)
    2. Commodity Murabaha Finance
    3. Sukuk

    The Commodity Murabaha Finance (CBF) is used to finance the purchase of the new Airbus A320-200 aircraft and simulator equipments, while the purpose of the sukuk was to fund Air Asia's capital expenditure and working capital.

    The current and non-current portions of sukuk and CBF consist of 8.2% of total borrowings at a weighted average of 5.04 and 4.98 respectively. This form of financing has only been used by AirAsia of late as it has not been taken-up in year 2007. The gearing ratio for the company is dangerously high at 382%.

    PROTON Holdings Berhad

    PROTON was incorporated in 1983 to spearhead the automotive industrialization process. It commands a substantial share of the domestic market for passenger cars and has distribution networks in several other countries.

    Long and short-term borrowings consist of bankers' acceptance, revolving credit, bank overdrafts, bridging loans, long-term loans, lease and hire purchase, and capital grants by the Government to the Automotive Development Fund of RM50 million. Shareholder equity consists of RM 5.4 billion. Gearing ratio is very low at 4.3%.

    The company has not adopted any Islamic financing methods.

    SHELL Refining Company

    SHELL Malaysia is a part of a global group of energy and petrochemical companies dealing in the exploration and production of crude oil and natural gas, conversion of natural gas into liquid hydrocarbon products, and the refinery of crude oil and market lubricants.

    The company is financed mostly by term loans repayable between 2-5 years. A USD 330 million loan has been taken up to fund a capital expenditure project back in 1997 which is carried at varying rates according to prevailing SIBOR +0.315, with minor revisions in subsequent years.

    A derivative, the cross currency interest rate swap (CCRIS) had been used to hedge against fluctuations in the USD/RM exchange rate on its USD 140 million term loan. Shell Malaysia did not take-up any Islamic financing. Shareholders' equity is at RM1.9 billion, and the company has a gearing ratio of 25%.

    British American Tobacco Malaysia

    British American Tobacco is the market leader in the Malaysian cigarette industry, with more than 60% market share. BAT Malaysia manufactures and markets high quality tobacco products designed to meet diverse consumer preferences.

    BAT Malaysia uses only medium-term notes and commercial papers to fund its operations. There are three medium term notes with varying maturity dates of RM100 million, RM150 million, and RM400 million at a coupon rate of 4.95%, 4.58%, and 4.05% respectively.

    Derivatives such as forward foreign exchange contracts and currency options are used to hedge against price increases in future payments for leaf, wrapping materials, capital expenditure and services over the next 12 months. No Islamic financing is used. BAT has a shareholders' equity of RM406.8 million, and a high gearing ratio of 98%.

    Berjaya Corporation Berhad

    Berjaya is a diversified entity engaged in the core business of: consumer marketing and direct selling, financial services, hotels and resorts, gaming, and food & beverage.

    Berjaya uses irredeemable unsecured loan stock of RM69 million to fund its operations. Other methods of financing include 8% secured exchangeable bonds of RM900 million, secured and unsecured term loans of RM1.5 billion, cumulative convertible irredeemable preference shares, trade financing facilities, hire purchase and leasing, bank overdrafts, and shareholders' equity of RM10.2 billion. Gearing ratio is at a healthy 28%.

    The company has not taken up any Islamic financing.

    Fraser & Neave Holding Bhd (F&N)

    Among Malaysia's oldest companies, the F&N Group is one of the leaders in the soft drinks, dairies and glass industries in Malaysia.

    F&N assets and operation are finance by a combination of RM 1.3 billion equity and RM 1.2 billion of debt. There were no significant changes as compare to 2007 except an increase in long term debt by the issue of Medium Term Note (“MTN”) with a nominal value of RM300 million, with the tenure of 3 to 5 years. The purpose of this issue is to fund the capital expenditure and refinance the existing bank borrowing.

    Short term secured and unsecured term loan consists of Thai Baht, Renminbi, and Malaysia Ringgit which amount of RM 449.047 million. Medium-term notes and revolving credits are also a source of financing. Shareholders' equity is at RM1.2 billion, and gearing ratio is at an acceptable level of 30.4%. There are no Islamic financing used for F&N.

    Sime Darby Berhad

    Sime Darby is a Malaysian-based multinational, and is the result of several key businesses involving plantation, property, industrial, motors, energy and utilities.

    Sime Darby's long and short-term borrowings consist of term loans of RM 1.15 billion, redeemable convertible preference shares, subordinated unconvertible redeemable loan stocks, and bank overdrafts. There is shareholder equity of RM21.7 billion. Gearing ratio is low at 14.7%.

    They also use several kinds of Islamic financing- Al Murahabah Medium Term Notes, Bai' Bithaman Ajil, and Al Murahabah Commercial Papers.

    The percentage of Islamic financing used in comparison to conventional financing is 33.0% (1.6 billion/4.8 billion).

    5.0 Summary of findings

    The above companies have core businesses in the sectors of :

    • Construction
    • Aviation
    • Automotive
    • Petrochemical
    • Tobacco
    • Hotels and Resorts
    • Food & Beverage
    • Plantation

    Popularity of Islamic financing

    Islamic financing to Total Borrowings

    As can be seen from the chart above, only 9.9% of total borrowings consist of Islamic financing. The remaining 90.1% of borrowings are funded through conventional financing methods.

    Conventional financing methods

    The most popular conventional financing used to fund operations are term loans, of which 100% (8/8) of the above companies use. This is followed by revolving credits, bank overdrafts, and lease & hire purchase.

    6.0 Conclusion

    From the chosen eight companies above, we can see that conventional financing still remains to be the more popular form of financing. Term loans have been most commonly used due to its simplicity and flexibility, where businesses can easily obtain funds to meet their short-term, medium-term, or long-term needs. Revolving credits are also popular for its convenience where businesses can draw funds for operating purposes when necessary after paying a one-time commitment fee. Companies seem to prefer conventional forms of financing since this has served them well for many years since their businesses have been established and they see no need to shift to different methods of financing.

    However, of the eight, there are three companies who have taken up Islamic sources of financing. AirAsia and Sime Darby have only recently (2008) adopted this method of financing, whereas Gamuda has been using Murabahah medium term notes (MTNs) since mid-2005 to fund its operations. AirAsia and Sime Darby's portion of Islamic financing is 8.2% and 33% of total borrowings respectively. Although this may still be considered as a small figure, the initial adoption of Islamic financing demonstrates that there is growing awareness of Islamic products as a viable source of financing. Gamuda's use of MTNs for the past 3-4 years, to the extent that 82% of its current long-term borrowings consist of MTNs, signifies confidence in this form of financing.

    From this analysis, it has found that although there are companies who use sukuk to finance their operations, the remaining 62.5% do not. Although the sample size (eight companies) is too small to make a conclusive assumption as to the take-up rate of Islamic products among Malaysian companies, it does indicate that developments in Islamic finance do have its effects on the choice of financing among Malaysian companies.

    As companies become more aware of the benefits and advantages provided by Islamic financing- which is expected to occur with the rapid development and increasing encouragement by the Government to position Malaysia as an Islamic financial hub, it is expected that they would come to seriously consider the use of Islamic products such as sukuk to finance their local and overseas operations or expansions.

    As Syariah law is open to interpretation, and religious boards hold different interpretations of key Syariah issues, there is contention over the approval of Islamic sukuk for sale. Complex sukuk structures involve challenging procedures and require extensive and costly advice, both legal and religious in addition to diverse sets of skill and resources to make them work. Therefore, corporations and banks often shy away from such structures due the legal risks and the potential costs of pioneering such instruments.

    Conventional finance would probably remain as the preferred form of financing, but if Islamic financial products prove to provide more advantages to the firm, in terms of increased flexibility, better terms and conditions, or better risk profile, this would greatly increase the chances of companies taking up Islamic financing as their preferred choice of financing. With increasing efforts by the Bank Negara Malaysia (BNM) and Syariah boards to standardize the terms of sukuk, this would definitely facilitate the conformity of financial services to Islamic law, which would improve take-up rates by companies in the near future.

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