How Khazanah launch Malaysia's first social impact bond

Khazanah Nasional is set to issue Malaysia's first social-impact sukuk, in a boost to the country's ambitions as a centre for socially responsible investment.

Local agency Ram Ratings said the M$1bn (US$282m) Sukuk Ihsan programme, to which it assigned a AAA rating last week, was the first social-impact bond to be rated globally. Proceeds will go towards educational projects.

Socially responsible investment is catching on slowly in Asia, but issuers in South Korea, India and Taiwan have sold so-called Green bonds and interest from investors is growing. The Asian Development Bank launched its first Green bond in March, raising US$500m.

"Although the global SRI market is still nascent, we see tremendous growth potential given Malaysia's leadership in the global Islamic finance market, as well as the increasing global and domestic demand for greater governance and ethical investments," said Ram Ratings CEO Foo Su Yin.

ISLAMIC PRINCIPLES

Investors and market observers are eagerly expecting the first issuance off the programme as early as next month, although marketing preparations are still being finalised.

Green or SRI investments complement the principles of Islamic finance, which call for money to be used for the protection and preservation of society.

Malaysia is the world's biggest Islamic bond market, accounting for about two thirds of all sukuk sold. According to the ADB, Malaysia had M$574bn (US$161bn) of local currency sukuk outstanding at the end of 2014.

"Demand will be good," said one investor keenly interested in the deal. "There are lots of shariah funds that will want this as this deal is memang Islamic." Memang is a Malay word for absolutely.

Ihsan Sukuk, set up as a funding conduit, will be the issuer, with Khazanah the obligor under the programme. CIMB is the sole arranger.

Malaysia's Securities Commission released guidelines last August to facilitate the creation of an "eco-system conducive for SRI investors and issuers, and also in line with the rising trend of green bonds and social impact bonds".

Among the projects deemed eligible for the SRI sukuk are environmentally friendly ones that promote renewable energy or reduce greenhouse gas emissions, or improve the quality of life for society. Educational projects fall under the community and economic development category.

PRINCIPAL LOSSES

While Green bonds are designed to be commercially similar to conventional investments, Khazanah's impact bond will require investors to be prepared for principal losses.

The Ihsan SRI sukuk incorporates a unique feature where the principal amount is reduced when the selected project hits certain key performance indicators.

This means investors will not recover the original sum put in, although they will continue to enjoy an income from the annual distribution rates or coupons. That suggests annual returns will be key in driving demand.

The sukuk also allows investors to waive their rights through the sales of the notes to Khazanah for a nominal consideration. Ultimately, the bondholders will look to Khazanah to fulfil the bond obligations.

The principal reduction mechanism is a new feature for which local investors will need education, but many already appear willing to accept the feature.

"While pricing is a factor, investors will buy these bonds as essentially buy-and-hold assets," said the local investor.

Bankers said the bonds could attract a large investor base as corporate investors with corporate social responsibility agendas could target such investments.

"Investments in SRI sukuk will not entirely be commercial decisions, but the ethical profile can provide an additional incentive," said a debt capital markets banker.

-Reuters