The Finance in the Capital Market and Credit Rating in Malaysia

Hidetoshi Hashimoto

Assistant Professor at the College of the Economics, Nihon University
1-3-2 Misakicho, Chiyoda-ku, Tokyo, 101-8360, Japan
Phone: ＋81-3-3219-3472
Fax: ＋81-3-3219-3472
E-Mail: hashimoto.hidetoshi@nihon-u.ac.jp
URL: http://www.eco.nihon-u.ac.jp

This paper is part of the research on “Model Building on Standardization of Assessment
Methods of Credit Risk in Major Asian Countries”

Center for China and Asian Studies
Nihon University College of Economics
1-3-2 Misaki-cho, Chiyoda-ku Tokyo 101-8360
Phone: ＋81-3-3219-3523
Fax: ＋81-3-3219-3529

0[Malaysia]
Table of Contents
1. Financial/ Capital Market in Malaysia(1) General feature of the capital markets in Malaysia(2) Financial markets and corporate finance(3) Bond markets in Malaysia(a)Government bond market(b) Corporate bond (Private Debt Securities: PDS) market(c) Corporate Islamic bond (sukuk) market
2. Credit Rating Agency(1) Requirements for the credit rating agency(2) General features of credit rating agencies(3) Rating methodology(4) Rating distribution(5) Default rate(6) Cumulative default rates(7) Rating-transition matrix
3. The problems to be solved for the bond market development

References11. Financial/ Capital Market in Malaysia(1) General feature of the capital markets in Malaysia
The financial system in Malaysia before the Asian currency crisis strongly depended
on the banking sector. Banking sector consist of commercial bank, merchant bank anddiscount house, and commercial bank account almost 80% of total asset of banking
sector. On the other hand, market size of the equity market was relatively larger thanthat of other ASEAN countries. 707 companies were listed and market capitalization
was 375.8 billion ringgit as at 1997. Regarding the corporate bond (Private Debt
Securities: PDS) market, market size enlarged from the early 1990s through 1996 dueto the expansion of the investment for the capital-intensive industry and infrastructure
project. Under this situation, the first Malaysian credit rating agency Rating Agency
Malaysia (RAM) was established in 1990. Then in order to deal with market expansion
and promote sound market competition, second Malaysian credit rating agency
Malaysian Rating Corporation Berhad (MARC) was established in 1995. Moreover,market infrastructure was also developed by the central bank (Bank Negara Malaysia;
BNM). Namely the Bond Information and Dissemination System (BIDS) which is the
database on ringgit debt securities were established in 1997.
After the crisis, finance sector reform was carried out under the strong initiative of
the government. Commercial banks were reorganized including other financial
institutions into 11 groups. In addition, banks became sensitive to a credit
concentration risk which reflected prudential regulations such as the strict single
customer limit. Moreover, driver of the economic growth turned into the consumption
from investment and in accordance with this change, the presence of the service sectorrose. As a result, the production structure of the banking sector shifted to working
capital and the retail sector service namely housing loan, car loan and credit cardbusiness etc.
In the bond market, issuance of government bond increased due to expansion of
government expenditure. On the other hand, regarding the PDS market, althoughmany corporate bonds with bank guarantee was issued before the crisis, the ratio wasdecreased greatly after the crisis. As a result, the PDS market became the financial
source of the long term capital for the firms which had high creditworthiness. Today, themarket size of the Malaysian bond market is the third place next to Japan and Korea.
In addition, the market size of the equity market also continues expanding, and as of2009, 960 companies were listed and the market capitalization was 999.45 billion
ringgit.
2

Meanwhile, the existence of the Islamic finance is very important feature of the
Malaysian financial sector. Especially after the crisis, the government has made effort
to develop the market, and today, Islamic debt securities (sukuk) count more than 60%of the outstanding amount of corporate bonds.
(2) Financial markets and corporate finance
Until 2008, the equity market was composed by the Main Board, 2nd Board andMESDAQ market which were high-growth and technology companies markets. From
2009, Main Board and 2nd Board are consolidated into Main Market, the MESDAK
market extended the target company, and the name was changed to the ACE market.
The number of listed companies and the market size are shown in Table 1 and Table 2.
Main Market plays a role as the financing source for the big companies, and the ACE
market plays a role as the financing source for the other high-growth and technology
companies. The main sector which is issuing equities includes service and commercial
sector, finance sector, consumer goods sector and plantation sector.
Table 1: Total Number of Listed Companies (as at 4 April 2011)
Ye ar
2011
2010
2009

Main Marke t *
840
844
844
Main
B o ard

2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990

Se c o n d
B o ard

634
636
649
646
622
598
562
520
498
474
454
444
413
369
347
329
317
292
271

221
227
250
268
278
276
294
292
297
283
282
264
208
160
131
84
52
32
14

Note*: Excludes ETFs and REITs
Source: Bursa Malaysia

3

ACE Marke t
114
113
116

To tal954
957
960

MESD AQ
Marke t
122
124
128
107
63
32
12
-

977
987
1027
1021
963
906
868
812
795
757
736
708
621
529
478
413
369
324
285

Table 2: Market size of the equity market
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009

Turnover (million units)
Main Board
2nd Board Main Market ACE Market
66,326.10
9,082.60
43,681.00
5,983.00
47,024.30
8,193.30
80,374.00
22,444.90
78,131.30
18,515.80
73,815.79
15,160.81
121,285.92
21,946.21
253,287.71
32,750.74
108,479.29
9,564.13
127,379.78
10,407.31
72,224.75
7,150.60

Total
75,408.60
49,663.00
55,630.20
112,183.20
107,610.20
102,338.21
197,508.80
360,370.45
141,004.51
234,256.32

Turnover (RM million)
Main Board 2nd Board Main Market ACE Market
211,806.10
32,248.20
75,467.00
9,545.00
102,566.40
14,171.90
141,660.80
35,514.90
180,408.30
24,948.00
157,445.35
12,288.44
205,180.52
16,585.19
483,352.56
21,924.09
279,368.91
5,348.75
156,470.26
3,787.47
114,645.01
1,704.51

No. of Listed Market Capitalisation
Total
Companies(RM billion)
244,054.30
795
444.3585,012.00
812
464.98116,951.40
865
481.62
183,885.90
906
640.28215,622.80
963
722.04
177,321.07
1021
695.27
250,641.02
1027
848.70540,173.08
987
1106.15
289,249.51
977
663.80280,022.53
960
999.45

Source: Bank Negara Malaysia

In the PDS market, as mention above, reflects that the ratio of bond with bankguarantee decreased after a crisis greatly and direction of the bank credit shifted to theworking capital, the market becomes the financing source of the long-term capital of theissuers such as an infrastructure sector or the financial institution having highcreditworthiness. Although the maturity is depend on the interest environment, theratio of medium term note (maturity 1 to 5years) and long term bond have been
increasing. On the contrary, issuing of the short term bond within one year is very
limited generally. In addition, the corporate finance of the multinational enterprises
such as the manufacturing industry relatively depends on internal reserves, and the
medium and small-sized firms relatively depend on the borrowing from thedevelopment financial institutions (DFIs).
(3) Bond markets in Malaysia(i) Regulatory agencies
Regarding the Malaysian bond market, central bank (Bank Negara Malaysia: BNM)
and Securities Commission: SC are the regulatory agencies. BNM mainly relate todevelop the market infrastructures and foreign exchange policies to facilitate crossborder investment and market access. In addition, BMN licensed and regulated
government securities dealers. With respect to the development of the market
infrastructures, Automated trading system (Fully Automated System for Issuing/
Tendering: FAST), settlement system (Real Time Electronic Transfer of Funds andSecurities: RENTAS) and computerized database (Bond Information and Dissemination
System: BIDS) were developed by the BNM.
With respect to the SC, it was established on 1 March 1993 under the Securities
Commission Act 1993 and became the main regulatory agency of the Malaysian capital
market from 2000. Namely SC is approving authority for corporate bond issues,
regulating all matters relating to securities and futures contracts. Moreover, The SC
4administers the Capital Markets and Services Act 2007 (CMSA), which governs thedomestic corporate debt securities and corporate sukuk market. In addition, SC
released Capital Market Masterplan (CMP) On 22 February 2001 which is 10-years(2001-2010) comprehensive plan to develop capital market. In CMP, there are six key
objectives were identified. These objectives are that to be the preferred fund-raising
centre for Malaysian companies, to promote an effective investment management
industry and a more conducive environment for investors, to enhance the competitive
position and efficiency of market institutions, to develop a strong and competitiveenvironment for intermediation services, to ensure a stronger and more facilitative
regulatory regime and to establish Malaysia as an international Islamic capital market
centre. In order to achieve its objectives, the CMP sets out 152 detailed
recommendations. Out of 152 recommendations, 17 recommendations were related to
the Malaysian domestic bond market. As at end year of 2010, 95% of the 152
recommendations were successfully completed.
(ii) Market infrastructure and taxation
The issuing and auctioning of government and corporate debt securities areautomated through the Fully Automated System for Issuing/ Tendering (FAST) which
was upgraded to web-based application in 2005. The settlement of the primary andsecondary market transactions in government securities and unlisted corporate debt
securities are done by the Scripless Securities Trading System (SSTS), which is part of
the Real Time Electronic Transfer of Funds and Securities (RENTAS) systemestablished in 1999. Meanwhile, in order to enhance transparency of secondary market
information, the Bond Information and Dissemination System (BIDS) was establishedin 1997. BIDS is a database on ringgit debt securities, providing information on theterms of issues, prices of trades, details of trades done including transactions on repo
activities and relevant news on the various debt securities issued by both thegovernment and the corporate sector. Financial institutions have the obligation toreport into BIDS details of trade done within 10 minutes of execution.
Regarding the Taxation, in order to develop the bond market, several tax incentives
were implemented. Tax treatment for issuers and investors are showed in Table 3.

5

Table 3: Tax treatment
Fo r I ssu e rs
Issuance for PDS are exempted from stamp dutyTax deductions on expenses incurred in the issuance of sukuk
Exemption from stamp duty (All instruments for the purpose of securitisation andsukuk issuance approved by the SC)
Securitisation exempted from real property gains tax
Tax-neutral for the originator and SPV in a securitization
Tax deductions for SPV in a sukuk transaction
Fo r I n ve sto rs
Exemption on interest income from ringgit-denominated debt securities and sukuk
Exemption on interest income from foreign currency-denominated sukuk
No stamp duty on transfers of MGS, PDS and sukuk
No capital gains tax
Source: Bank Negara Malaysia and Securities Commission (2009)(a) Government bond market(i) Outline of the government bond market
In government bond market, four types of securities that Malaysian Government
Securities (MGS), Malaysian Treasury Bills (MTB), Government Investment Issues(GII) and Malaysian Islamic Treasury Bills (MITB) are issued. MGS are interest
bearing long-term bonds and likewise, in order to develop benchmark yield curve,
original maturity is composed by 3-year to 20-year (3-year, 5-year, 10-year, 15-year and20-year). MTB are short-term securities with original maturity of less than one year
(3-month, 6-month and 1-year). GII and MITB are long-term and short-term
non-interest bearing securities based on Islamic principles 1 . Original maturity of GII is
more than three year (3-year, 7-year and 10-year), MITB is one year.
MGS were originally issued to meet the investment needs of the Employee Provident
Fund (EPF) and domestic financial institutions, and used for public sector’s
development expenditure. MTB are used for government’s working capital. GII and
MITB are issued for Islamic banks to enable to hold liquid papers as well as theinvestment instrument for Islamic banks. According to the Bank Negara Malaysia(2007), the conventional securities and the Islamic securities differ only in its structure
in terms of complying with Islamic principles in its issuance and Islamic government
securities are similar to conventional government securities in terms of their effective
cash flows, issuance structure, legal status in being a direct obligation of theGovernment, its holdings and nature of transaction as financial products.
For details of the structure of Malaysian government bond market, see Bank Negara
Malaysia (2007)

1

6

Regarding the composition of outstanding of the Malaysian government bond as at 31
December 2006, MGS account 88%, and follow GII=10%, MTB=1%, MITB=1%.
(ii) Primary and secondary market
Government bond is issued by market auction and private placement. MGS and GII
are issued according to the issuance calendar which is released in December prior to theissuance year and contains the following information namely types of Government
securities (MGS or GII), whether the issue is new or reopening, method of issuance(private placement or market auction) and month of issuance.
The participant of market auction is the Principal Dealers (PDs) and counterpart ofthe private placement is an identified institution approval from the Ministry of
Finance. In addition, the central bank has the option to participate in MGS auction forthe purpose of market operations. In the case of GII, all Islamic banks can participate
to the auction. In the market auction, all bids are submitted by PDs via Fully
Automated System for Issuing/Tendering (FAST) and if bids are successful, Real Time
Electronic Transfer of Fund and Securities (RENTAS) system will allot the securities
to the bidder and also settlement would be made automatically in this system. Primary
investors of government securities are the Employees Provident Fund (EPF), Petronas
which is largest petroleum company, financial institutions, insurance companies
including Islamic insurers, asset management companies and other corporations.
With respect to the secondary market, government securities are traded in thesecondary or over-the-counter market. All transactions are made through the Bond
Information and Dissemination System (BIDS) and all trading in the OTC market arealso captured by BIDS system. The settlement in the secondary market is made in RealTime Electronic Transfer of Fund and Securities (RENTAS) system. Repurchase
Agreement (Repo) market is also developed.
(b) Corporate bond (Private Debt Securities: PDS) market
PDS market is governed by the Capital Markets and Services Act 2007 (CMSA) andguidelines; Guidelines on the Offering of Private Debt Securities and Guidelines on theOffering of Islamic Securities. Under these guidelines, issuer can issue the PDS more
speedy because SC can give approval within a period of not more than 14 working days
from the date of receipt of the application. In addition, by issuance of the Guidelines on
the Offering of Private Debt Securities, examination system for the bond issuance waschanged from Merit Base Qualification to Disclosure-Based regulatory: DBR regime 2 .
2Under the Merit Base Qualification, issuer who met an industrial policy of the7

Under the DBR regime, issuers can issue the bond when they disclose enoughinformation the market and investors judge that issuers are worth to invest. Moreover,a requirement of the minimum credit rating was also dispensed. Thus, by implementing
these policies, bond issuers became able to issue bonds on the market base condition.
Regarding the types of securities, following types of debt securities are issued namely
straight bonds, Medium-term Notes (MTNs), Commercial papers (Cps), convertible
bonds, bond with warrants and zero coupon bonds. Debt securities which listed on theexchange market are known as loan stocks. Besides these securities, Asset-backed
securities (ABS), securities which issued by Khazanah Nasional Berhad, the investment
holding arm of the government (Khazanah bonds) and securities which issued by
Cagames Berhad, national mortgage corporation (Cagamas papers) are also issued.
Excluding the Khazanah bonds and Cagamas papers, breakdown of the debt securities
are shown in figure 1. From figure 1, the ratio of the straight bonds has been decreased.
Figure 1: Breakdown of the debt securities: conventional + Islamic

Source: Annual reports of Securities Commission.

The change of the PDS issuance is shown in figure 2. From figure 2, we can see PDS
issuance had significantly grown from 2000 to 2007. According to the BNM’s annual
report, main factor of bond issuance is debt restructuring and refinancing before 2004
and after 2004, finance for the new business activity is driver for the market expansion.
On the other hand, bond issuance is decreased from 2007 to 2009. This cause is effect ofinternational financial crisis. In addition, decrease of lending rate of banks due toexpansionary financial policy may be the one of the factors.

government was able to issue a bond.
8

Figure 2: PDS Issues approved

Source: Annual reports of Securities Commission.

Regarding the bond issuer and investor profile, as see in figure 3, transport &communication, utilities and construction sector is main issuer and with respect to bondinvestor profile, institutional investors such as pension fund, insurance company andmutual fund are main investors. Among these investors, the ratio of the pension fund ishigh. In Malaysia, there are some pension funds such as Employees Provident Fund:
EPF, Social Security Organization: SOCSO, Armed Forces Fund and Teachers Provident
Fund, and EPF is the most important investor. Although it was requested that EPF
applied more than 70% of investment by government bonds until the early 1990s, after
that, the ratio has been decreased. Because asset of EPF is basically invested indomestic market, it can be guessed that the investment with the corporate bond has
been increased. Based on the author’s calculation, EPF hold the about 11% of theoutstanding amount of the corporate bond as at 2006.
Figure 3: Bond Issuer profile: 2000-2008

9

Source: Bank Negara Malaysia and Securities Commission Malaysia (2009)．

Regarding the cross border investment, it was increased after 2004 because of market
infrastructure development (Figure 4). For example, Bank Negara Malaysia liberalized
its foreign exchange regulation on April 2004 which allowing multilateral developmentbanks (MDBs) or multilateral financial institutions (MFIs) to issue Ringgit
denominated bonds. Then on April 2005, foreign exchange administration rules further
liberalized as income from investment in Ringgit-denominated debt securities is
exempted from withholding tax. These liberalizations of the foreign exchange regulation
may contribute to the increasing of the cross border investment. Although after 2007,
the level is decrease temporary because of international financial crisis, it is recoveredfrom 2008.
Figure 4: Cross border investment (Long-term debt securities)(USD million)

Source: IMF: Portfolio Investment: Coordinated Portfolio Investment Survey (CPIS) Data Geographic Breakdown Tables(c) Corporate Islamic bond (sukuk) market
Malaysia is well known for the one of the most successful international Islamic
financial center of the world. Malaysian government is eager to have developed theIslamic finance especially since Asian currency crisis. Indeed, as mention above,
development of Islamic finance was one of the main objectives of the Financial Sector
Masterplan, and also, in 2006, central bank released the policy of “MalaysianInternational Islamic Financial Center”.
According to the Bank Negara Malaysia and Securities Commission (2009), sukuk
are the financial document on certificate of equal value that represent an undivided
interest in the ownership of an underlying asset, usufruct, services or investments inparticular projects or special investment activities. Correspondent to this concept,
sukuk are issued under the Islamic principles and concepts which comply with Islamic
10

law Shariah. Shariah concepts and principles which applied to sukuk are showed inTable 4. Regarding the feature of sukuk, sukuk investors have some level protection
which may not be available from conventional bonds because sukuk are backed byassets. On the other hand, sukuk have some similarities with conventional bond, in thatthey are similarly structured based on assets that generate revenue.
Table 4: Definition of the Shariah concepts and principles

Mu syarakah (Profit and Loss-sharing)Mu dh arabah (Profit-sharing)

Ijarah (Leasing)

A partnership arrangement between two parties or more to finance a businessventure, where all parties contribute capital either in the form of cash or in kindfor the purpose of financing the business venture. Any profit derived from theventure will be distributed based on a pre-agreed profit-sharing ratio, but a loss
will be shared on the basis of equity participation.
A contract between 2 parties to finance a business venture. The parties are a
rabb al-mal or investor, who solely provides the capital; and a mudharib or
entrepreneur, who solely manages the project. If the venture is profitable, theprofit will be distributed based on a pre-agreed ratio. In the event of a businessloss, it shall be borne solely by the provider of the capital.
A manfaah (usufruct) type of contract, where a lessor (owner) leases out anasset or equipment to its client at an agreed rental fee and pre-determinedlease period upon the ‘aqad (contract). The ownership of the leased equipment
remains in the hands of the lessor.

A contract that refers to the sale and purchase transaction for the financing ofBai’ Bith aman Ajil or B B A (Deferred-payment Sale) an asset on a deferred and instalment basis, with a pre-agreed payment period.
The sale price will include a profit margin.

Istisn a’ (Purchase Order)

A purchase contract for an asset, where a buyer will place an order to purchase
the asset that will be delivered in the future. In other words, the buyer will
require a seller or a contractor to deliver or construct the asset that will becompleted in the future, according to the specifications in the sale andpurchase contract. Both parties in the contract will decide on the sale andpurchase prices as they wish, and settlement can be delayed or arranged basedon the schedule of work completed.

Mu rabah ah (Cost-plus Sale)

A contract that refers to the sale and purchase transaction for the financing ofan asset, where the cost and profit margin (mark-up) are made known andagreed to by all parties involved. The settlement of the purchase price can beeither on a deferred lump-sum basis or an instalment basis, which will be
specified in the agreement.

Source: Bank Negara Malaysia and Securities Commission Malaysia (2009)

Correspond to the series of government's policies, presence of sukuk have been
increasing. From figure 5, outstanding amount of sukuk have increased since 2001.
Especially, corporate sukuk market expanded rapidly in comparison with that ofgovernment bonds. Moreover, with respect to the proportion between corporate sukuk
and conventional corporate bonds, the ratio of sukuk have been increased steadily, andas at the December 2007, sukuk accounts for shares more than 60% in corporate bondmarket (Figure 6). In addition, Malaysian sukuk market marks a leading position in theworld. From Table 5, the amount outstanding of sukuk in Malaysia dominates that ofother countries.

11

Figure 5: Change of the outstanding amount of the sukuk in Malaysia(USD million)(USD mil)
70000
60000
50000

Corp
Gov

40000
30000
20000
10000
0
2001

2002

2003

2004

2005

2006

2007

Source: Asia Bond Indicator．

Figure 6: Ratio of sukuk among corporate bond markets in Malaysia
100%
90%
80%
70%
60%
Conventional
Islamic

50%
40%
30%
20%
10%
0%
Dec-01

Dec-02

Dec-03

Dec-04

Dec-05

Dec-06

Dec-07

Source: Asia Bond Indicator．

Table 5: Leading sukuk issuing countries: 2007
(USD million)
Cou n t r y

G ov er n m en t

Cor por at e

T ot alBah r ain

617

400

1,017

Br u n ei Dar u s s alam

222

－

222

Cay m an Is lan ds

－

100

100

In don es ia
K u wai t
Malay s ia
P ak i s t an
Q at arSau di Ar abia

81
3,777
339
－
－

113
993
22,752
725
450
4,350

193
993
26,529
1,065
450
5,683

Su danU n it ed Ar ab Em ir ates

－
3,425

130
7,292

130
10,717

8,461

37,306

47,10018.00%

79.20%

T ot al
P er c en t ag e

Source: Extracted from Askari et al. (2009), p22．

12

Regarding to the Issuer profile of corporate sukuk, as see in Table 6, sukuk are issued
mainly by infrastructure & utilities, financial services, diversified holdings andproperty & real estate sector in value base. On the other hand, if we look in the number
of issues base, industrial products sector can be added as a one of the main issuers.
Table 6: Corporate Sukuk issuer plofile as at December 2009(%)

by valu e
Infrastructure & utilities
Financial services
Diversified holdings
Property & real estate
Trading & services
Asset-backed securities
Industrial products
Construction & engineering
Mining & petroleum
Plantation & agriculture
Consumer products
Transportation
Public FinanceTotal

by n u mbe r o f issu e s

47
14
11
9
6
4
3
2
1
1
1
1
0
100

24
6
4
15
7
11
13
4
2
9
1
3
1
100

Source: Islamic Banking and Finance Institute Malaysia, (2009)．

With respect to the breakdown of the Shariah concepts for sukuk, Malaysian sukuk
market started by Bai’ Bithaman Ajil: BBA (Deferred-payment Sale) and variety of
Shariah concepts which apply for the sukuk have been expanded (Table 7). Until 2003,
Shariah concepts which are based of sukuk consist of the BBA, Murabahah (Cost-plusSale) and Istisna’ (Purchase Order). Then Ijarah (Leasing) scheme was introduced in
2004 and from 2005 sukuk which based on Musyarakah (Profit and Loss-sharing) and
Mudharabah (Profit-sharing) were issued. This expansion of Shariah concepts for
Sukuk may contribute to facilitate to bond issuing and market development. As at
December 2009, the ratio of Musyarakah is highest (36%), and follows with Murabahah(27%), BBA (22%) in value base (Table 8). On the other hand, with respect to thenumber of issues base, the ratio of the Murabahah, BBA and Ijarah is high.

13

Table 7: Change of the Shariah concepts (value base)(%)

20 0 1BBA
Mu rabah ahIstisn a'
IjarahMu syarakah
Mu dharabah

2002
77
10
13

67
33

2 0 03
40.8
12.7
46.5

2 0 04
56.88
38.27
2.8
2.05

2 00 5
36.3
33.5
14.5
2.9
12.6
0.2

2 00 6
6.2
9.4
2.1
4.9
70
7.5

20 0 7
2
19
9
11
58
1

Source: Annual reports of Securities Commission.

Table 8: Breakdown of the Shariah concepts for Corporate Sukuk market
as at December 2009(%)

by valueMusharakah
Murabahah
BBA
IjarahIstisnaMudharabah
Total

36
27
22
8
6
1
100

by n umbe r of issu es
11
34
29
20
3
3
100

Source: Islamic Banking and Finance Institute Malaysia, (2009)

2. Credit Rating Agency(1) Requirements for the credit rating agency
In order to be recognized as credit rating agencies (CRAs), applicant must meetcriteria which are issued by SC in 2006; PRACTICE NOTE issued pursuant to the

Guidelines on the Offering of Private Debt Securities and the Guidelines on the Offeringof Islamic Securities.
Recognition criteria and important notices are as follows.
(a) Capital requirement and financial resources

A CRA shall maintain minimum shareholders' funds of RM10 million at all
times.

(b) Shareholding structure

A CRA shall have an appropriate shareholding structure that will ensure and14maintain its independence and objectivity in rating bonds.
(c) Rating methodology and process


A CRA shall use established rating methodologies and processes that are robust,systematic and apply them consistently. Rating methodologies shall be modified
and tailored for each type of bond and industry to which they are applied. A CRA
shall, where relevant, incorporate corporate governance analysis into its rating
framework to assess any impact on credit risks.

(d) Transparency and disclosureThe rating reports shall contain all pertinent information with sufficient
analytical depth both quantitative and qualitative.

(e) Independence, objectivity and conflict of interest

Where the analyst or rating committee member, or any of his family member,has an interest in the bond issue, the analyst or rating committee member of a
CRA shall not be involved in the rating and monitoring process or decide on
ratings.

A CRA shall establish appropriate policies and procedures governinginvestments in and trading of securities by its employees.



A CRA shall disclose all material conflicts of interest to the public in its rating
reports.

(f) Monitoring of bonds rated by CRAs
A CRA shall conduct rating reviews of outstanding bonds and publish its rating
opinions and reports on a timely and consistent basis. Rating upgrades anddowngrades from a CRA shall be timely.



A CRA shall initiate immediate review of rating status upon becoming aware of
any information that may reasonably be expected to result in a rating action.

(g) Human resources and expertiseA CRA shall have sufficient number of analysts who are qualified to carry out
rating assignments and subsequent monitoring of the bonds.



A CRA shall provide adequate training for its analysts and notify the SC of the
training programs and continuing professional education programs that its
analysts attended at the end of each calendar year.

(h) Operational requirements


A CRA shall have adequate infrastructure to provide reliable bond rating
services and maintain its credit rating operations and a CRA shall maintaininternal records to support its credit opinions for a reasonable period of time orin accordance with applicable laws.
15



A CRA and its staff shall maintain confidentiality of the information obtained
from its clients in accordance with the confidentiality agreements entered intowith its clients.

(j) Fit and proper requirements


A CRA and every person who is, or is to be, a director, chief executive and key
personnel of the applicant shall be fit and proper persons.

(k) Adoption of the International Organisation of Securities Commission’s Code of
Conduct Fundamentals for Credit Rating Agencies (IOSCO CRA Code)A CRA shall adopt the IOSCO CRA Code in its own code of conduct and disclose
it on its website.

Where the CRA's Code of Conduct differs in substance from the provision of the
IOSCO CRA Code, the CRA shall explain where and why these differences
exist, and fully disclose this on its website.

(2) General features of credit rating agencies
In Malaysia, there are two domestic credit rating agencies such as Rating Agency
Malaysia Berhad: RAM and Malaysian Rating Corporation Berhad: MARC are
operating. Outline of these agencies are shown in Table 9. Rating Agency Malaysia
Berhad was established in November 1990 as a first Malaysian domestic CRA. Today,
Rating Agency Malaysia Berhad has been operated as a subsidiary of the RAM Holdings
and renamed to “RAM Ratings”. Other than Rating Agency Malaysia Berhad, RAM
Holdings hold subsidiaries such as RAM Ratings (Lanka) Limited, RAM Consultancy
Services Sdn Bhd. Also, RAM Holdings has given technical assistance to Bangladesh’s
Credit Rating Information and Services Limited (or CRISL) and affiliate with Standard& Poor's (S&P). Share holders of RAM Holding are consisted of domestic financial
institutions, Asian Development Bank (ADB) and Fitch Ratings.
Malaysian Rating Corporation Berhad (MARC) was established in October 1995 andbegan operation from 1996. Share holders of MARC are consisted of domestic insurancecompanies, stock brokers and investment banks. Also MARC is affiliate with Fitch
Ratings.
Regarding the rating definition, both agencies use same ratings symbols in longterm rating from AAA to D. However, RAM Ratings applies subscripts 1, 2 or 3 in eachrating category from AA to C and MARC applies subscripts plus (+) or minus (-) in eachrating category from AA to B. with respect to the short term rating, RAM categorized
rating as P1, P2, P3, NP and D. MARC categorized rating as MARC-1, MARC-2,
16

MARC-3, MARC-4 and D.
Table 9: Outline of the Malaysian domestic credit agencies
I n c o rpo ratio n

Ratin g Po rtf o lio

T ype s o f Se rv ic e s

Mappin g

Sh are h o lde rs

B re ak do w n o f
s h are h o lde rs

H is tro y

RAM Ratin g s
November 1990
Local and foreign corporates, multinationals, banks, insurancecompanies, government-linked and other public-financed
entities, myriad complex investment vehicles and the ringgitdenominated securities they issue, structured-financetransactions backed by receivables or other financial assets, andIslamic securities (commonly known as sukuk).
Corporate Ratings, Project Finance Ratings, Structured FinanceRatings, Sukuk Ratings and Financial Institution and Insurer
Ratings

Malays ian Ratin g Co rpo ratio n B e rh ad ( MARC)
October 1995
Corporates and corporate debt issues, including Islamic capital market
instruments, asset-backed securities, as well as financial strength
ratings of financial institutions and insurance companies.

Long-term (AAA, AA, A ,BBB, BB, B, C, D). Short-term(P1,P2,P3,NP,D)

Long-term (AAA, AA, A ,BBB, BB, B, C, D). Short-term (MARC-1,
MARC 2, MARC-3, MARC-4, MARC-5)

Corporate Debt Ratings, Issuer Ratings, Islamic Capital Market
Instrument Ratings, Asset-Backed Securities (ABS), Financial
Institution Ratings, Corporate Credit Ratings, Insurer Financial
Strength Ratings, Islamic Financial Institution Governance Ratings andSovereign Issuer Credit Ratings

Wholly owned by RAM Holdings Berhad. Ultimate shareholders of The major life and general insurance companies, stockbrokers andinvestment banks in Malaysia. Each shareholder owns no more than
RAM Holdings comprise major financial institutions in Malaysia,
4.9% equity in MARC.
Asian Development Bank and Fitch Ratings.
Affin Bank Berhad 3.6%
Affin Investment Bank Berhad 2%
Alliance Bank Malaysia Berhad 3.2%
Alliance Investment Bank Berhad 2%
AmBank (M) Berhad 3.3%
AmInvestment Bank Berhad 3.5%
Asian Development Bank 4.9%
Bangkok Bank Berhad 0.8%
Bank of America Malaysia Berhad 2.1%,
Bank of Tokyo-Mitsubishi UFJ (Malaysia) Berhad 2.1%
Boon Siew Credit Berhad 0.3%
CIMB Bank Berhad 14.425%
Citibank Berhad 3.5%,
Deutsche Bank (Malaysia) Berhad 0.8%
EON Bank Berhad 1.8%
Fitch Ratings Limited 4.9%
Hong Leong Bank Berhad 4%
HSBC Bank Malaysia Berhad 3.5%
J.P. Morgan Chase Bank Berhad 1.3%
Kewangan Bersatu Berhad 0.7%
Malayan Banking Berhad 6.9%
OCBC Bank (Malaysia) Berhad 3.5%
Public Bank Berhad 5.325%
RHB Bank Berhad 8.85%
RHB Bank Berhad (RMBB Assets) 1.2%
SIBB BERHAD 1.2%
Standard Chartered Bank Malaysia Berhad 3.5%
The Bank of Nova Scotia Berhad 1.3%
The Royal Bank of Scotland Berhad 1.3%
United Overseas Bank (Malaysia) Berhad 4.2%

I n s u ran c e Co mpan ie s
Berjaya Sompo Insurance Bhd
BH Insurance (M) Bhd
CIMB Aviva Assurance Bhd
Etiqa Insurance Bhd
Great Eastern Life Assurance (Malaysia) Bhd
ING Insurance Bhd
Jerneh Insurance Bhd
Kurnia Insurans (Malaysia) Bhd
Lonpac Insurance Bhd
Malaysian Assurance Alliance Bhd
Malaysian Reinsurance Bhd
Manulife Holdings Bhd
MSIG Insurance (Malaysia) Bhd
Prudential Assurance Malaysia Bhd
S to c k bro k e rs
AmSecurities Holding Sdn Bhd
Hwang-DBS (Malaysia) Bhd
Inter-Pacific Securities Sdn Bhd
JF Apex Securities Bhd
Rashid Hussain Bhd
TA Enterprise Bhd

RAM Ratings was established in November 1990 as Rating
Agency Malaysia Berhad. On 1 July 2007, Rating Agency
Malaysia Berhad became the one of the three subsidiaries of
RAM Holdings and remaned to RAM Ratings. RAM Holdings
have three main subsidiaries: RAM Ratings and RAM Ratings(Lanka) Limited (which provide credit-rating services in theirrespective markets), and RAM Consultancy Services Sdn Bhd(which supplies innovative risk-management solutions as well as
strategic business and advisory services)

D is c o u n t H o u s e s
Abrar Discounts Bhd
Investment Banks Affin Investment Bank Bhd
Hong Leong Investment Bank Bhd
KAF Investment Bank Bhd
Kenanga Investment Bank Bhd
Maybank Investment Bank Bhd
MIDF Amanah Investment Bank Bhd
OSK Investment Bank Bhd
Public Investment Bank Bhd
MARC was established in October 1995 and commenced operations
on 17 June 1996. Then, officially launched on 5th September 1996
by the Deputy Prime Minister and Minister of Finance, Malaysia.

Source: RAM web site (http://www.ram.com.my/) and MARC web site (http://www.marc.com.my/)(3) Rating methodology
According to RAM’s Rating Methodology Corporate Credit Ratings (2006), credit
rating agencies consider following factors; industry risk, business risk, financial risk
and management quality. For each factors, industry risk is evaluated by growthpotential, vulnerability to industry factors, barriers to entry, threats of substitutes andlevel of competition. For estimation of business risk, the 2 areas normally covered,namely market risk which is consider basis of competition, market position and size,
product/service diversity and customer analysis, and operating risk which is consider
plant facilities and location, availability of raw materials, efficiency of assets, cost
structure, labor relations, credit controls and inventory management. Financial risk isevaluated by profitability & coverage, funding structure, capital structure/leverage,
cashflow stability and adequacy and financial flexibility & liquidity. Management
quality contains following factors namely corporate goals & strategies, risk tolerance,
17

financial policies, succession planning/family-owned outfit, credibility & integrity andother organizational considerations.
(4) Rating distribution
Regarding the long term rating, almost all rating consists of investment grade from
AAA to BBB (Figure 7). In the first half of the 2000s, ratio of A is relatively high. Thenafter 2005, the tendency is observed that ratio of AAA and AA is increased.
Simultaneously, ratio of the P1/MARC-1 has been increased in short term rating (Figure
8).
Figure 7: Rating distribution: Long term (No. of issues)

Source: Annual reports of Securities Commission.

Figure 8: Rating distribution: short term (No. of issues)

Source: Annual reports of Securities Commission.

18

(5) Default rate
As see in Table 10, from the RAM’s data, although default rate is high in 1998 byreflecting Asian currency crisis, the level is low as a whole. With respect to that of
MARC, the tendency is similar. However, the level in 2009 is higher than that of RAM.
Meanwhile, when we see the proportion between investment grade (AAA to BBB) andspeculative grade, default rate of the speculative grade is much higher than that ofinvestment grade for both rating agencies.
Table 10: Annual corporate default rate
(%)
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Total

RAM ( 1 9 9 7 - 2 0 0 9 )
0.6
8.8
2.5
3.6
2.3
0.0
1.9
1.1
3.3
0.0
1.0
1.1
1.6
1.9

M ARC ( 2 0 0 1 - 2 0 0 9 )
0.0
0.0
0.0
0.0
2.4
1.0
4.5
1.8
5.6
2.5

0.7(*)
9.1(*)

1.6(**)
12.5(**)

Investment grade
Sepeculative grade

Note*: weighted average of 1992-2009
Note**: average of 2001-2009
Source: Rating Agency Malaysia Berhad (2010a) and Malaysian Rating
Corporation Berhad (2010)．

Then, when we see the relation between default rate and industry from Table 11 andTable 12, it is worth to attention that the default rate of industrial products is high forboth agencies. This cause can be thought that industrial products sector is more affectedby the change of economic environment in comparison with other sectors. Indeed,according to the MARC (2010), the level of default rate in 2009 was reflected by the
economic recession from second half of the 2008 which affected global financial crisis. If
we consider this situation, it can be said that the ratio of industrial products sector
among issuer rated by MARC is higher than that of RAM. On the other hand, according
to the RAM (2010a), main issuers rated by RAM are consisted of finance andinfrastructure & utilities sectors. Therefore, we can say that RAM’s annual default rate
in 2009 was less than that of MARC.
Table 11: Default rates and distribution by industry (1992-2009): RAM

19

% of total defaults

Indu stry
Property & real estate
Industrial products
Diversified holdings
Trading & services
Financial services
Transportation
Infrastructure & Utilities
Construction & engineering
Plantation & agriculture
Overall

1 9 9 2 -2 0 0 9
Error
( %)
margin (% )1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
8
4
2
2
8
4
2
12
6
2
2
2
2
2
6
2
2
2
2
4
2
2
2
2
2
2
2
2
2
2
2
2
33
8
12
8
6
4
12
4
4
6

4.3
3.2
2.7
2.8
0.3
5.9
0.5
2.9
2.8
1.9

0.31
0.27
0.45
0.4
0.13
1.96
0.23
1.47
2.78
0.04

Source: Reproduced from Rating Agency Malaysia Berhad (2010a), p9．

Table 12: Annual corporate default rate by major industry: MARC(%)
Se c to r

2001 2002 2003 2004 2005 2006 2007 2008 2009

Construction
Consumer products
Finance
HotelsIndustrial products
Infrastructure & utilities
Insurance company
Plantation
Property
Technology
Trading/services
All corporate

-

-

-

-

9.1
2.4

5.6
1

12.5
6.9
4.2
5.3
4.5

3.7
6.3
1.8

13
3.8
9.1
5.6

Wtd.
Ave rag e
1 .9
0
2 .2
0
5 .8
1 .3
0
0
2 .4
0
1 .8
2 .5

Source: Reproduced from Malaysian Rating Corporation Berhad (2010), p13.

(6) Cumulative default rates
Regarding the RAM’s cumulative default rates from one to five years, the high rating
has low default rate, and a default rate is high in the low rating generally (Figure 9).
However, when we see the BB and B, the default rate of B is lower than that of BB. It is
explained that this cause is little number of the samples of low rating category.
Meanwhile, MARC shows cumulative default rates from one to eight years, andbasically the structure is almost same as that of RAM (Figure 10). However, it might bereflected it’s shorter track record, distance between AA and A is broader than that of
RAM and the rating of lower than BB is displayed in aggregate.

Figure 9: One to 5 year cumulative default rates (1992-2009):RAM (%)
20

C

BB
B
BBB
A
AA

Source: Reproduced from Rating Agency Malaysia Berhad (2010a), p10．

Figure 10: Cumulative default rates by rating corhort: MARC (%)

BB & Lower

BBB
A
AA
AAA

Source: Malaysian Rating Corporation Berhad (2010).

(7) Rating-transition matrix
When we see the data of RAM in Table 13, the one year rating sustentation rate ishigh in the high rating (AAA and AA) and that of MARC is also high (Table 14). Because
ratio of AAA and AA rating bonds are high in Malaysian market, it can be thought thatstable rating is given to the published bonds. In addition, rating-transition matrix of the
Malaysian domestic rating agency is more detailed than that of other ASEAN countries.
This might be relatively abundant samples and track records of Malaysian domestic
rating agencies.

Table 13: Cumulative 1-year rating-transition matrix (1992–2009): RAM
21

Source: Reproduced from Rating Agency Malaysia Berhad (2010b), p23．

Table 14: 1-year migrations at modifier level 1998-2009
AAA
AA+
AA
AAA+
A
ABBB+
BBB
BBBBB+
BB
BBB+
B
BC

AAA
AA+
AA
AAA+
A
ABBB+ BBB BBB- BB+
BB
BBB+
B
BC
93.3
0.0
1.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
7.1
89.3
0.0
3.6
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
5.7
80.0
5.7
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
8.0
76.0
2.7
0.0
1.3
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
8.4
72.3
6.7
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.6
6.1
74.0
5.5
1.1
0.6
1.1
0.0
0.0
1.1
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
8.5
66.0
3.2
0.0
2.1
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
25.0
50.0
0.0
6.3
0.0
0.0
0.0
0.0
6.3
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
50.0
16.7
0.0
0.0
0.0
16.7
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
7.1
0.0
57.1
0.0
7.1
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
33.3
33.3
33.3
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
62.5
0.0
0.0
12.5
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
16.7
66.7
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0

NR
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0

5.7
0.0
8.6
12.0
10.1
7.7
16.0
12.5
0.0
14.3
0.0
0.0
12.5
0.0
50.0
0.0
0.0

Default
0.0
0.0
0.0
0.0
1.7
2.2
4.3
0.0
16.7
14.3
0.0
0.0
12.5
100.0
50.0
16.7
0.0

Source: Reproduced from Malaysian Rating Corporation Berhad (2010), p27.

3. The problems to be solved for the bond market development
As we having discussed, Malaysia has the most developed bond market among
ASEAN countries. By tightened up the prudential regulations for banks, bond market
has acted the role as the financial source of the long term capital for the firms. Also aseries of the government policies supported for the expansion of the market size.
Moreover, domestic credit rating agencies contribute for the market development byoffering the appropriate credit risk information to investors.
However, in order to create more developed bond market, we can indicate a problem
to solve. That is rating band is concentrated into AAA and AA, and it is very difficult for22relatively high-risk issuers to issue bonds. Surely credit rating agencies give theappropriating rating ex-post. However, basically only a company had highcreditworthiness issue a corporate bond. As mentioned before, main issuers of corporatebond are finance and infrastructure and utilities sectors which are relatively hard to be
influenced by the change of the economic environment and the cash flow is more stable
than other industrial sectors. Therefore, it is thought that these issuers’ bond havetendency to get high rating while issuer of other sectors are hard to access the corporatebond market.
In order to facilitate to market access for the lower rated issuers, enhancement ofliquidity is very important. If liquidity rises, investors can hold relatively high riskedbond more easily. Moreover, to enhance the function of bond market as financing source
for issuers, it is necessary to expand the investor base. In Malaysia, presence of pension
fund as investors is high and it is difficult for investment in a high-risk corporate bondin nature. Therefore, by expanding investor base including the cross-border investment,
the function as the financing source of the bond market is enhanced and financing costof issuers will decrease.

References
Askari, Hossein., Zamir Lqbal and Abbas Mirakhor (2009) New Issues in Islamic
Finance & Economics: Progress & Challenges, John Wiley & Sons (Asia)
Pte.Ltd.
Bank Negara Malaysia, Annual Report, several issues.
――― (2007) A Guide to Malaysian Government Securities 2007 Second Edition.
――― and Securities Commission Malaysia (2009) Malaysian Debt Securities and

Sukuk Market - A Guide for Issuers and InvestorsIslamic Banking and Finance Institute Malaysia (2009) Islamic Finance Bulletin,
October - December 2009, Issue #26.
Malaysian Rating Corporation Berhad (2010) 2009 Annual Corporate Default and

Rating Transitions Study: Update on Long-term Corporate Rating
Migrations and Defaults from 1st January to 31st December 2009.
Rating Agency Malaysia Berhad (2006) Rating Methodology: Corporate Credit Ratings,
April.
―――(2008) Corporate Default & Ratings Performance Study (1992 - 2007), August.

―――(2010a) 2009 Corporate Default & Ratings-Performance Study (1992-2009).

―――(2010b) 2009 Rating-Migration by Notched Ratings (1992-2009).
23

Securities Commission, Annual Report, several issues.
―――(2006) PRACTICE NOTE issued pursuant to the Guidelines on the Offering Of

Private Debt Securities and the Guidelines on the Offering Of Islamic
Securities: Recognition of Credit Rating Agencies by the Securities
Commission for the Purpose of Rating Bond Issues, 25 January.

24