1

FINANCIAL MARKET DEVELOPMENTS IN 2011 __________________________________________________________________________ OVERVIEW The purpose of this report is to provide an overview of the developments, business activities and initiatives for the financial market in 2011. The report also shares, for the first time, information of the volume and major players of various financial instruments available for the year based on a survey conducted by Bank Negara Malaysia. 2011 was an eventful year for international financial markets; one marked by natural disasters, political upheaval in the Middle East and Africa (MENA) region, escalation of the European sovereign debt crisis and volatile capital flows. The Malaysian financial markets, however, remained resilient against this backdrop, and remained stable with ample liquidity supporting market activity and intermediation. In the domestic money markets, surplus liquidity conditions provided a buffer in facing volatile portfolio flows. Total transactions in the conventional money market amounted to RM19.8 trillion in 2011, increasing by RM1.3 trillion compared to 2010. The debt securities market also expanded, affirming its size as the largest in South East Asia. Various efforts were undertaken to promote liquidity in the secondary debt securities market, which includes five reopenings of GIIs that was significant given it is the world’s first ever reopening of a sukuk that shares the same financial parameters of the existing sukuk and comply with Shariah requirements. Significant headways were also made in the arena of Islamic finance, with Malaysia increasing its role as an international market for raising both ringgit and foreign currency funds. In 2011, Islamic Development Bank (IDB) launched its USD750 million 5-year sukuk, and the Malaysian government also successfully issued a 5-year and 10-year Wakala sukuk worth USD1.2 billion and USD800 million respectively. Reflecting the growing importance of CNY currency in the the region, a landmark CNY denominated sukuk worth CNY500 million was issued by Khazanah. In 2011, the Bloomberg Malaysian Foreign Currency Sukuk Index (BMSSUTR) was also developed to provide global sukuk fund managers with an additional benchmark option for global sukuk. Conditions in the foreign exchange markets were more volatile in 2011. The volatility of the ringgit exchange rate reflected mostly external developments revolving around the European sovereign debt crisis and the US sovereign ratings downgrade. The depth of the domestic FX market continued to grow in depth and liquidity. Of note, total FX trading involving the renminbi increased 4 times the amount in 2010, reflecting the various initiatives in promoting the use of renminbi for trade settlement purposes. Meanwhile, the derivatives market recorded a vast increase of 24.8% compared to 2010 as investors actively hedge their portfolio positions amidst the worsening European sovereign debt crisis and political turmoil in the MENA region.

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MONEY MARKET Money Market Weathered Challenging Global Environments The year 2011 witnessed several challenging events which led to large shifts in global liquidity in and out of emerging economies, including Malaysia. In the first half of 2011, against the backdrop of highly accommodative monetary policy and low growth prospects in the advanced economies, portfolio flows to emerging economies, including Malaysia, rose significantly. This led to a surge of excess liquidity in the domestic money market, higher demand for short-term papers and increased trading activities in the market. Chart 1: Aggregate surplus liquidity placed with BNM

0

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100

150

200

250

300

350

400

450

J F M A M J J O S O N D

RM billion

MM Borrowing Repo Borrowing

Wadiah Acceptance Murabahah Commodity Acceptance

BNMN BNMNI

Others SRR

Source: Bank Negara Malaysia

In the conventional money market, total trading volume amounted to RM19.8 trillion, a 6.8% increase compared to 2010, and instruments comprise deposits, bankers’ acceptances (BAs) and negotiable certificate of deposits (NCDs). Deposits were the main instrument traded with 98.0% of total trading volume, and a turnover ratio of 52.98x1 . NCDs recorded the most significant percentage increase in trading activity i.e. 62.7% to RM265.6 billion, whilst trading in BAs remained in the region of RM135 billion to RM140 billion in 2010 and 2011. Similar to the conventional market, trading volume in the Islamic money market also increased by 43.0% to RM2.66 trillion, with Mudharabah placement capturing 83% of total trading. Other instruments, such as Commodity Murabahah, NIDC and Wadiah placement recorded volumes ranging around RM100 billion to RM110 billion respectively.

The changes in excess liquidity due to portfolio inflows and the subsequent reversal also led to higher trading activities in the short-term bills market. Total trading of conventional Bank

1 Based on average aggregate surplus liquidity of RM366.56 billion in 2011

3

Negara Monetary Notes (BNMNs) increased by 60% to RM1.22 trillion, with a turnover of 14.9x2. Islamic BNMNs were also heavily traded, recording a 3 fold increase from RM157.6 billion in 2010 to RM477.5 billion, with a turnover of 17.9x3. The yields of 3-month and 6-month BNMNs traded close to OPR, reflecting the strong demand of investors for this instrument. Despite market expectations for the MPC to raise the OPR in May 2011, the 3-month and 6-month BNMN yields on average traded only 3 bps and 7 bps above the OPR prior to May 2011. After the increase in OPR, and during the second half of the year, BNMN yields overall traded below the OPR following the continued high demand, despite some portfolio outflows which began from August to October due to the US debt ceiling crisis and sovereign downgrade, as well as the worsening condition in the European sovereign debt crisis. Chart 2: BNMN yields vs OPR

2.50

2.75

3.00

3.25

Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11

Yield (%)

OPR

3-month BNMN

6-month BNMN

Source: Bank Negara Malaysia

In managing the levels of market surplus liquidity during the year and facilitate the demand from investors, the issuance of Bank Negara Monetary Notes (BNMNs) was increased during periods of portfolio inflows and subsequently decreased towards end of the year due to flow reversal. Early in the year, total BNMN outstanding amounted to RM96.4 billion, reaching a peak of RM127.7 billion in September 2011 and gradually declined to RM107.2 billion by the end of the year.

2 Based on average BNMN (conventional) outstanding of RM82.63 billion in 2011

3 Based on average BNMN (conventional) outstanding of RM82.63 billion in 2011

5 May 2011: The OPR was raised by 25bps to 3% to address upside risk to inflation

4

Chart 3: Outstanding Bank Negara Monetary Notes

Source: Bank Negara Malaysia

Several initiatives were undertaken to enhance the variety and diversity of money market instruments in 2011. A new feature introduced in the auction for deposit placements with BNM this year was the range maturity auction (RMA) which allows banks to choose their own tenors to tender within the range tenor that is offered by BNM. With the RMA, financial institutions can manage their liquidity more precisely with the option to match a part of their excess ringgit funds according to their liabilities profile. For the Islamic money market, two new Islamic monetary instruments were introduced. The first is Bank Negara Malaysia Monetary Notes-Istithmar (BNMN-Istithmar), which is based on the Istithmar (investment) concept that refers to portfolio investments that comprise of Ijarah (lease) and Murabahah (commodity cost-plus) transactions. This new monetary instrument is widely accepted by Islamic banks in Malaysia and is tradable in the secondary market. The second instrument is the Bank Negara Malaysia Monetary Notes-Bai Bithaman Ajil (BNMN-BBA), which is similar to the existing Murabahah-based BNMN-i, in that both represent indebtedness arising from deferred payments on commodity Murabahah sale transactions between the issuer and investor. The BNMN-BBA, however, does not have secondary market tradability features, thus satisfying a different Shariah interpretation on the debt trading (Bay Al Dayn) prohibition. In addition, the Bank is currently collaborating with AIBIM and industry players to develop a collateralised murabahah structure that is based on widely accepted Shariah principles, and it is envisaged that this product will help to develop the Islamic repo market in Malaysia. Another key initiative to support domestic and regional money market activities is the establishment of the cross border collateral arrangements (CBCA) with other central banks in the region. The CBCAs would enable Malaysian financial institutions operating in foreign countries to obtain liquidity from the foreign central banks by pledging Ringgit denominated securities and vice versa, thus mitigating liquidity risk for banks looking to expand their business. The Bank has already established such arrangement with the Monetary Authority of Singapore and the Bank of Thailand. With more countries in the region participating in this initiative, this will reinforce financial and economic integration and support cross border financial market activities.

5

DEBT SECURITIES MARKET Malaysian Debt Securities Market Expanded Further in 2011 The ringgit debt securities market grew by 10% in 2011 to a total market size of RM841 billion outstanding or 98.6% of GDP. Malaysia remained the largest debt securities market in South East Asia, comprising 60% of Government securities and 40% of corporate debt securities, a structure similar to most developed Asia markets. Chart 4: Size of Debt Securities Market

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100

150

200

250

300

Malaysia Thailand Singapore Indonesia Philippines

Billion (USD)

0

20

40

60

80

100

120

% of GDP

2010 2011 2011 % of GDP

Source: Asian Bonds Online

The sukuk market recorded a significant 19.1% growth to RM350 billion, contributing largely to the growth of debt securities market. Currently, the sukuk market accounts for 41.6% of total debt securities market outstanding. Chart 5: Outstanding Debt Securities

39 55 71 88 96 120 146 199 211 248 294 350225 246 236277 284

298306

358 375395

469491

0

200

400

600

800

1000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

RM billion

Islamic Conventional

Source: FAST

6

In 2011, Malaysia’s fiscal deficit narrowed to 5.0% of GDP (2010: 5.6% of GDP), supported by strong revenue performance. Gross issuance of government debt securities increased 55% to RM90.2 billion in 2011, due to larger debt repayment (RM45 billion) and higher development expenditure (RM46.4 billion) to support economic growth. Net issuance also increased by RM11 billion to RM45.2 billion, bringing the total outstanding government debt securities to RM387.7 billion at the end of the year. This increase in net issuance was managed by introducing new tenors (15-year MGS and 7-year GII) and increasing the frequency to 21 issuances in 2011 (2010: 17 issuances). Market demand remained high with a narrow average auction tail of 0.81 bps and high average bid-to-cover ratio of 2.27 times. Chart 6: Government Securities Maturity Profile as at end 2011

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10

20

30

40

50

60

2011 2013 2015 2017 2019 2021 2026 2028 2031

RM billion

2011 Issuance

Oustanding at end of 2010

Source: Bond Info Hub

Table 1: Weighted Average Duration

Average duration End of Year

MGS GII Overall

2010 4.48 4.55 4.50

2011 4.30 4.32 4.31

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2011 Auction Analysis Competitive Bids Throughout the Year…

Table 2: Summary of MGS/GII Auction ‘11

No MGS/GII Bid-to-cover Average

Successful Yield

Tail (bps)

1 10-year MGS 2.30 4.160 1.00

2 3.5-year MGS 2.19 3.434 0.60

3 7.5-year GII 2.41 3.872 0.60

4 5-year MGS 2.24 3.567 0.80

5 3.5-year GII 1.43 3.505 1.50

6 15-year MGS 2.30 4.392 0.80

7 10-year GII 3.03 4.170 0.50

8 7-year MGS 1.63 3.747 0.80

9 5.5-year GII 1.91 3.710 0.90

10 10-year MGS 2.34 3.970 0.70

11 20-year MGS 2.52 4.232 1.80

12 5-year MGS 2.11 3.518 0.20

13 10-year GII 3.71 4.009 0.50

14 15-year MGS 1.87 3.916 1.40

15 5-year GII 2.84 3.375 0.50

16 7-year MGS 1.67 3.580 0.90

17 3-year MGS 2.39 3.133 1.00

18 10-year MGS 2.11 3.792 0.70

19 7-year GII 2.60 3.677 0.30

20 5-year MGS 1.78 3.303 1.00

21 3-year GII 2.19 3.204 0.60 Malaysian Government Securities (MGS) In 2011, gross issuances of MGS increased by 46.1% to RM54.2 billion, with relatively strong average bid-to-cover ratio of 2.12 times. Insurance companies and institutional investors displayed higher demand for longer-tenured papers with the 20-year benchmark recording the highest bid-to-cover ratio of 2.52 times. The Government had also introduced a 15-year MGS in 2011, which received equally strong demand. The inaugural issuance in April 2011 recorded a 2.30 times bid-to-cover ratio, with demand from insurance companies who acquired 15% of the total issuance. While domestic players actively participated in auctions across all tenures, non-residents focused on the shorter-tenured MGS. In 2011, 61% of non-residents’ successful bids were in the shorter-tenured MGS. Chart 7: MGS Allotment

8

Government Investment Issues (GII)

GII gross issuances totaled RM36.0 billion, a 71.4% increase from 2010. Biddings were competitive with average bid-to-cover ratio having increased from 2.37 times in 2010 to 2.63 times, reflecting greater depth and participation in the Islamic capital market. Similar to MGS auctions, market participants, mainly institutional investors, showed higher interest in the longer end of the curve with the 10-year benchmark recording the highest bid-to-cover of 3.71 times. Non-residents, however, were primarily focused in the 5-year GII, with 98% of their total GII successful bids in that tenure. Nonetheless, non-residents participation in the GII market remains low, with holdings of only 0.5% of the outstanding GII as at end 2011. Chart 8: GII Allotment

9

Initiatives to Improve Secondary Market Liquidity Several initiatives were undertaken to enhance secondary market liquidity. Among the initiatives were the reopenings of GII where a 5-year GII was reopened for the first time in May 2011, followed by four subsequent GII reopenings. The reopening of GII was significant as it marked the world’s first reopening of a sukuk that not only comply with Shariah requirements, but shares the same financial parameters of the existing sukuk, making them fungible assets. The reopening of GII increases the outstanding size of sukuk issuance, which will promote greater liquidity. Consequently, the secondary trading volume for GII doubled to RM476.8 billion in 2011 (2010: RM206.4 billion). An MGS switch auction was also successfully conducted on 7th Dec 2011, which aimed at increasing the secondary market liquidity and smoothening the debt maturity profile. A total of RM3.1 billion MN02/13 was switched for MS10/13. Chart 9: Comparison in Secondary Bond Market Trading Instruments for 2010 and 2011

i-PDS

5%PDS

3%

Islamic short-

term bills

8%

GII

11%

Conventional

short-term bills

41%

MGS

32%

Islamic short-

term bills

14%

PDS

3%

i-PDS

4%

MGS

30%

GII

14%

Conventional

short-term bills

35%

2010 - RM1.91 tn 2011 - RM3.42 tni-PDS

5%PDS

3%

Islamic short-

term bills

8%

GII

11%

Conventional

short-term bills

41%

MGS

32%

Islamic short-

term bills

14%

PDS

3%

i-PDS

4%

MGS

30%

GII

14%

Conventional

short-term bills

35%

2010 - RM1.91 tn 2011 - RM3.42 tn

Source: Bond Info Hub Overall secondary market volume registered marked improvement, with average daily turnover of RM13.9 billion and turnover ratio of 4.07 for 2011 (annual trading volume for 2011: RM3.42 trillion; 2010: RM1.91 trillion). Trading activities of Islamic short-term bills tripled, increasing by RM320 billion compared to 2010, following stepped up issuance of Islamic BNMN issuance. Wider participations by non-residents in both the government and central bank debt securities markets, also contributed to the active trades of Malaysian debt securities. In 2011, non-residents contributed to 18.6% of the total secondary trades while non-residents holdings account for 19.6% of the total outstanding securities as at end 2011. Accordingly, Ringgit bond yield curves declined and flattened during the first three quarters of the year, driven by ample domestic liquidity and persistent portfolio inflows. Ringgit bond yields however, firmed-up temporarily in mid-September with yields rising by 27bps to 41bps across the yield curve following deteriorating financial market condition and concerns over the Euro zone debt crisis which led investors to reduce exposures across the emerging markets. As a result, non-residents holdings of ringgit bonds fell by RM23.9 billion from its peak of RM190.2 billion recorded in 14th Sept 2011. The bulk of liquidation by non-residents were in the short-term bills market. Although short-term yields rose marginally due to the sudden

10

selloffs, the yields gradually recovered towards the end of 2011 as expectations for slower economic growth weighed in against the non-residents liquidations. Chart 10: Malaysian Government Securities Yield Chart for 2011.

2.5

3

3.5

4

4.5

5

5.5

6

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec2011

Yield (%)

OPR 1 year 3 Year 5 Year 10 year 15 year

• February: large auction size of 3-year MGS amounting to RM4.5 billion resulted in higher short-term yields

• April: inflow of funds by NR pressured yields lower

• OPR increased 25bps to 3.00% in May

• Middle East’s geo-political tensions and Japan’s tsunami prompted investors to invest in the more stable bond markets instead of equity markets

• September: worsening of European debt crisis prompted NR to sell ringgit bond and return to safe-haven currencies

Source: Bloomberg

Chart 11: Non-residents Holdings of Government Securities and BNMNs

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20.00

40.00

60.00

80.00

100.00

120.00

Jan-11 Feb-11Mar-11 Apr-11 May-11Jun-11 Jul-11 Aug-11Sep-11 Oct-11 Nov-11Dec-11

RM billion

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

% of O/S

MGS+GII Bills

% of MGS+GII o/s % of Bills o/s

Source: Monthly Statistical Bulletin, BNM website

11

Fund Raising Activity in the Corporate Debt Market Continues to Expand In the private debt securities market, corporations stepped up issuances, capitalising on the low yield levels. Total gross issuance in 2011 increased by 15% to amount to RM95.7 billion, while total corporate bond outstanding expanded to RM342 billion or equivalent to 40% GDP by end 2011. Product offerings also expanded in diversity, with the issuance of multi-currency bonds namely in US dollar and Chinese renminbi. The year recorded large corporate debt issuances especially by financial institutions, which saw RM18.1 billion worth of issuances. Hong Leong Financial Group Berhad, Malayan Banking Berhad and Public Bank Berhad topped the list of issuances in the financial sector with sizes of RM3 billion and higher. Large debt issuances were also seen from the energy industry as companies were expanding their power generation plants to meet the rising electricity demand in Malaysia and growing electricity export market. Among the large issuances were Manjung Island Energy Berhad (RM4.9 billion), Sarawak Energy Berhad (RM3.0 billion) and YTL Power International Berhad (RM2.5 billion). Issuance in the corporate bond segment was dominated by sukuk, accounting for 61% of total issuance. Driven by a very competitive avenue for fund raising, the sukuk market has become the preferred market for corporations. The largest sukuk for 2011 was the Pengurusan Air SPV Berhad’s issuance of RM9.9 billion under its RM20 billion medium-term notes programme to undertake the financing for acquisition of water assets and accompanying liabilities in Peninsular Malaysia and Labuan. In 2012, this was topped by another mega sukuk programme of RM34.35 billion in mid-January by PLUS. Chart 12: Outstanding Corporate Debt Securities for 2010 and 2011

181 206

138136

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100

200

300

400

2010 2011

RM billion

Islamic Conventional

Source: FAST

12

Chart 13: Outstanding Sukuk in Malaysia

2011

Corporate

52%

Cagamas

3%

BNM

9%

Govt.

32%

201120102009200820072006

RM billion

Government 21.6 30.0 44.5 68.0 83.5 112.0

BNM 10.0 20.5 8.7 8.4 29.5 31.8

Cagamas 6.1 11.6 8.4 11.5 13.9 10.8

Khazanah 7.4 6.4 7.4 8.0 10.0 13.2

Corporate 101.3 131.0 146.4 159.6 167.3 182.4

TOTAL 146.4 199.4 211.4 248.5 294.2 350.2

201120102009200820072006

RM billion

Government 21.6 30.0 44.5 68.0 83.5 112.0

BNM 10.0 20.5 8.7 8.4 29.5 31.8

Cagamas 6.1 11.6 8.4 11.5 13.9 10.8

Khazanah 7.4 6.4 7.4 8.0 10.0 13.2

Corporate 101.3 131.0 146.4 159.6 167.3 182.4

TOTAL 146.4 199.4 211.4 248.5 294.2 350.2

Source: FAST

The Malaysian sukuk market is emerging as a prime international market attracting foreign entities to raise both ringgit and foreign currency funds. A favourable environment, competitive tax structure, comprehensive financial infrastructure, robust governance framework coupled with ample liquidity in Malaysia are among the contributing factors elevating Malaysia as the preferred domicile. During the year, Kuwait-based Gulf Investment Corporation (GIC) successfully issued a RM750 million sukuk Wakala bi Istithmar under its existing 20-year RM3.5bil (US$1.18 billion) medium term notes programme.

Issuer Structure Amount Tenure

International Finance Corporation (World Bank)

Bai Bithaman Ajil RM500 million 2004 - 2007

Nomura Holdings Inc. Ijarah US$100 million 2010 - 2012

General Electric Capital Corp. Ijarah US$500 million 2009 – 2014

National Bank of Abu Dhabi Murabahah Murabahah

RM500 million RM500 million

2010 – 2015 2010 – 2020

Meanwhile, foreign currency sukuk issued out of Malaysia has also gained momentum under the MIFC initiative:

• Islamic Development Bank (IDB) launched its USD750 million 5-year sukuk in May 2011, with a dual listing in London Stock Exchange and Bursa Malaysia. The issue received strong participation from the Asian and MENA region, which formed 80% of the total allocation.

• Khazanah marked a landmark issuance of CNY denominated sukuk of CNY500 million.

• Malaysian government successfully issued 5-year and 10-year Wakala sukuks (with issue size of USD1.2 billion and USD800 million, respectively) in June 2011. These offerings were listed in Hong Kong Stock Exchange, Bursa Malaysia and Labuan International Financial Exchange. It represents the largest dual-tranche global sovereign US dollar sukuk and the first 10-year global sovereign US dollar sukuk ever issued. The sovereign sukuk were over-subscribed by 4.5 times, reflecting investors’ confidence in Malaysian credit and scarcity of such papers globally.

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In profiling the visibility of Malaysian sukuk market, the Association of Islamic Banking Institutions Malaysia (AIBIM), Bursa Malaysia and Bloomberg jointly developed the Bloomberg AIBIM Bursa Malaysia Sovereign Shariah Index (BMSSI) with objectives of promoting sukuk issuances and providing benchmark indices to the growing number of investors of Malaysian-based sukuk. In complementing this, BNM and Bloomberg jointly developed the Bloomberg Malaysian Foreign Currency Sukuk Index (BMSSUTR) consisting of investment-grade sukuk listed in Bursa Malaysia and Labuan International Financial Exchange (LFX). The index provides global sukuk fund managers with an additional benchmark option for global sukuk. The BMSSUTR index has been used as the performance benchmark by fund managers as its constituents are mostly liquid sukuk, making them a good representative of the sukuk space. Moving forward, the Bank will collaborate further with institutional investors, fund managers and index providers to further refine and widen the use of the index with the objective of strengthening Malaysia’s position as a leading sukuk market in the world as well as placing Malaysia as the international sukuk centre. Chart 14: Bloomberg Malaysian Sukuk Ex-MYR Index Total Returns

98

99

100

101

102

103

104

105

106

Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11

Mid Price /100

Source: Bloomberg

Malaysia continues to be the leader in the international sukuk market, accounting for 60% share of global outstanding sukuk as at end 2011. With the large financing requirements for infrastructure projects under the Economic Transformation Programme (ETP), the Malaysian sukuk market is expected to thrive further. In addition, few other Gulf Cooperation Council entities are setting up sukuk programmes in Malaysia which will further add diversity of issuers in the Malaysian market, increase international connectivity and enhance the pace of internationalisation of Islamic finance.

14

Chart 15: Global Sukuk Outstanding

2010

Saudi Arabia

8%

Singapore

0%

Others

7%

Cayman Island

8%

Indonesia

3%

Pakistan

1%

UAE

5% Bahrain

2%

Malaysia

66%

2011

Malaysia

60%

Bahrain

2%

UAE

2%

Others

13%Singapore

0%

Pakistan

2%

Saudi Arabia

7%

Indonesia

3%

Cayman Island

11%

Country 2006 2007 2008 2009 2010 End Dec-11

Malaysia 27,239 52,027 58,190 70,972 93,281 108,087

Bahrain 550 1,062 1,412 2,597 2,782 3,629

UAE 1,775 6,267 7,316 7,316 7,116 3,284

Cayman Island 500 5,030 7,127 10,558 11,858 19,628

Indonesia 87 264 939 2,602 1,368 6,316

Pakistan 144 839 1,126 1,506 1,788 4,159

Saudi Arabia 1,208 4,641 6,515 8,775 11,362 12,422

Singapore - - - 264 300 370

Others* 1,531 5,191 7,605 8,955 9,487 22,563

TOTAL 33,034 75,321 90,230 113,545 142,342 180,458

Country 2006 2007 2008 2009 2010 End Dec-11

Malaysia 27,239 52,027 58,190 70,972 93,281 108,087

Bahrain 550 1,062 1,412 2,597 2,782 3,629

UAE 1,775 6,267 7,316 7,316 7,116 3,284

Cayman Island 500 5,030 7,127 10,558 11,858 19,628

Indonesia 87 264 939 2,602 1,368 6,316

Pakistan 144 839 1,126 1,506 1,788 4,159

Saudi Arabia 1,208 4,641 6,515 8,775 11,362 12,422

Singapore - - - 264 300 370

Others* 1,531 5,191 7,605 8,955 9,487 22,563

TOTAL 33,034 75,321 90,230 113,545 142,342 180,458

USD million

*Others include Bermuda, Brunei, Gambia, Bermuda, Egypt, Jersey, Kuwait, Sudan, Iran, Qatar, Yemen, Turkey, Hong Kong and UK Source: IFIS

15

FOREIGN EXCHANGE MARKET Ringgit performance Similar to many emerging market and global currencies, the ringgit was heavily influenced by developments in the Euro zone and the US. In the first half of 2011, sentiment was improving following signs of recovery, albeit a slow one, in Europe and the US. Regional currencies strengthened and the ringgit reached a high of 2.9340 on 27th July 2011. Substantial portfolio inflows were recorded during the period due to the strengthening economic fundamentals and positive investors’ sentiment on the implementation of various government economic programs. Furthermore, exporters were also active in hedging forward sales of foreign currency receipts as expectation of sustained ringgit strength was widespread. However, by August, a series of negative developments in international markets saw ringgit retraced. These developments prompted investors to rebalance their portfolio of higher yielding assets, including emerging markets, into the major and “safe-haven” currencies such as USD, JPY and CHF. Ringgit volatility rose significantly during this period, together with other regional currencies (Chart 18). Ringgit 1-month volatility rose to as high as 13.6% in October before settling around 8-9% level towards year end. Ringgit and other regional currencies showed signs of stabilizing in November and December 2011. This was also evidenced in regional equity bourses which consolidated in the final two months with declining volatility. Ringgit closed 3.46% lower for the whole year of 2011 (source: Bloomberg), in line with the rest of regional currencies which depreciated against the US dollar, with the exception of Chinese renminbi (Chart 18). Among regional, Thailand baht notably closed 5.01% lower because of the extraordinary flooding while Singapore dollar weakened only by 1.14% following its perceived status as “safe-haven” currency in this region. Chart 16: Currency Performance against the US dollar for 2011 and 2010

11.07%

9.73%

3.21%

11.75%

9.32%

4.59%

5.69%

3.44%

-15.93%

-5.01%

-3.87%

-3.49%

-3.46%

-1.14%

-0.99%

-0.43%

4.68%

4.05%

-20%-15%-10%-5%0%5%10%15%20%

INR

THB

TWD

KRW

MYR

SGD

IDR

PHP

CNY

2011

2010

USD StrengthenUSD Weaken

Source: Bloomberg

16

Chart 17: Normalised Selected Currency Movement against the US dollar for 2011

Source: Bloomberg

Chart 18: Regional currencies 1-month volatilities in 2011

0

5

10

15

20

25

30

Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11

1M Vol (%)

KRW IDR

MYR SGD

THB CNY

Source: Bloomberg

Foreign Exchange (FX) Market Turnover FX market turnover increased by 43% from US$2.11 trillion in 2010 to US$3.01 trillion in 2011, or 11.0 times Malaysia’s Gross Domestic Product (GDP) in 2011, a substantial increase from 8.9 times GDP in 2010. FX turnover over Malaysia’s trade (import and export) increased to 7.3 times in 2011 from 5.8 times in 2010. The increase in FX market turnover was mainly contributed by higher FX spot trading, followed by higher FX swap. Both FX spot and FX swap contributed 89% to total FX market turnover last year.

17

Cross currency swap turnover surged by almost 4 times mainly due to increase in non-resident activities with financial institutions, which contributed 97% or US$ 79 billion to the US$ 81 billion rise in cross currency swap turnover in 2011. Table 3: FX Market Turnover for 2011 vs. 2010

Year FX Spot FX Forward FX Option FX Swap Currency Swap

Total FX Market

2011 US$1,961 bn US$198 bn US$12 bn US$732 bn US$109 bn US$3,011 bn

2010 US$1,397 bn US$125 bn US$9 bn US$555 bn US$28 bn US$2,113 bn

Change from 2010 to 2011

+US$564 bn +US$73 bn +US$3 bn +US$177 bn +US$81 bn US$898 bn

% Increase +40% +58% +35% +32% +293% +43%

Source: ROMS

Chart 19: FX Market Trading by Instrument Types

2011

FX

Swap,

24%

FX

Forward,

7%

FX

Option,

0%

FX Spot,

65%

Currency

Swap,

4%

2010

FX

Swap,

26%

FX

Forward,

6%

FX

Option,

0%

FX Spot,

66%

Currency

Swap,

1%

Source: ROMS

For year 2011 as a whole, the increase in gross portfolio investment flows by non-resident and goods flows by residents, have contributed to the higher FX spot trading turnover in 2011. FX spot activities were highest during the ringgit strengthening period in April and again during portfolio deleveraging period in the month of September. The increase in the trading range and volatility sparked demand from corporate customers to actively hedge, translating into the high FX turnover during these two periods. By Q4 2011 however, FX spot trading began to decline mainly due to dampened investors’ sentiment on regional assets and long year-end holidays.

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Chart 20: Monthly Turnover by Instruments vs. USD/MYR in 2011

0

50

100

150

200

250

Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11

USD bn

2.85

2.90

2.95

3.00

3.05

3.10

3.15

3.20

FX Spot

FX Forward

FX Option

FX Swap

Currency Swap

USD/MYR (RHS)

Source: ROMS and Bloomberg

Third Currency Trading Activities The bulk of FX market turnover in 2011 was in the USD/MYR pair, accounting for 81% of total turnover. Of note, the trading of third currency pairs (non-ringgit against non-ringgit) has increased by 64% to US$488.34 billion in 2011. The major contributor to the increase was active trading of major currency pairs such as EUR/USD, AUD/USD and GBP/USD. Third currency trading is viewed as a new growth area both for major currency pairs and regional crosses given the internationalisation of Malaysia’s corporate and increased investment activities abroad (e.g. KWSP, KWAP, Axiata, Maxis, Resorts World and YTL) as well as greater acceptance in using regional currencies for trade settlement and investment. Chart 21: FX Percentage turnover by currency pairs

2011

USD/MYR,

81.4%

AUD/USD,4.2%

EUR/USD,6.0%

Others,4.5%USD/SGD,1.8%

GBP/USD,2.0%

2010

USD/MYR, 84.3%

AUD/USD,2.7%

EUR/USD,5.2%

Others,4.4%USD/SGD,2.0%

GBP/USD,1.4%

USD/MYR

EUR/USD

AUD/USD

GBP/USD

USD/SGD

Others

Source: ROMS

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Renminbi Trading and Trade Settlement Initiatives FX liberalisation by China to expand the use of renminbi for trade settlement is expected to lead to growth in the use for settlement of bilateral trade between Malaysia and China and serve as a catalyst for a Malaysian offshore renminbi market. The introduction of the trading between RMB and MYR in China’s interbank foreign exchange market, appointment of market makers for RMB/MYR in the China Foreign Exchange Trade System (CFETS) are expected to enhance liquidity in the trading pair. Subsequently, the Bank and the People’s Bank of China (PBC) have renewed the Currency Swap Arrangement (CSA) agreement this year and increased its size from RMB80 billion / MYR40 billion in 2009 to RMB180 billion / MYR90 billion. The objectives of the CSA remain to reinforce financial cooperation between both economies and to facilitate greater bilateral trade and investment. Since 2009, the Bank has supported the infrastructure development for the use of RMB/MYR. This includes:

• the setting up of RMB/MYR price (bid-ask) page on Reuters for on-line price reference and transparency to Malaysian exporters and importers. The RMB/MYR prices on the Reuters’ page are contributed by domestic financial institutions.

• liberalized its foreign exchange administration rules in allowing ringgit to be used for settlement of international trade in goods and services between a resident and non-resident. Hence, this complements the use of RMB and allows Chinese importers and exporters to pay and receive in ringgit.

• The Bank has also embarked on several nation-wide awareness campaign through a series of road shows across the country, engaging with commercial bank branches, corporations including the small and medium-sized companies, and multi-national corporations (MNCs) in dialogues and seminars to promote awareness on the availability of trade settlement in renminbi and to gather feedback on issues faced by corporations in settling trade in renminbi. In addition, the Bank has also produced bilingual pamphlets (in English and Mandarin) and soft copy version published on the Bank’s website.

As a result, total FX market trading involving renminbi (both interbank and corporate customers) reached US$3.85 billion in 2011, four times more than US$0.94 billion in 2010. The increase reflects various initiatives conducted by financial institutions and the Bank in promoting the usage of regional currency i.e. renminbi for trade settlement purposes.

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Chart 22: RMB FX Trading Turnover (USD/RMB and RMB/MYR)

2 57

940

3850

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2008 2009 2010 2011

US$ million

Source: ROMS

There are, however, challenges in implementing regional currency settlement:

• A lack of awareness on the benefits (such as incentives in the form of tax breaks to Chinese exporters) and the rules surrounding local currency settlement. Therefore, there is a need for financial institutions to play a role in bridging this gap.

• The wide use of US dollar to settle commodity trade (import and export) discourages corporations to migrate to regional currency settlement. However, as corporations become more comfortable and familiar in settling trade in regional currency, the regional currency settlement would gain traction moving forward.

• The thin market and lack of depth of foreign exchange trading between two regional currencies could also increase the cost of sourcing the currencies. Hence, the Bank will look into measures to support the development of the regional cross currency market.

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MALAYSIAN DERIVATIVES MARKET

The Malaysian derivatives market4 grew 24.8% in 2011, with trades amounting to RM460.8 billion. Heightened market volatility during the year due to political turmoil in the MENA region, and the escalating European sovereign debt crisis prompted investors to actively manage their portfolio positions, contributing to the higher volume in the derivatives market. Most of the trading was to manage interest rate exposures, which led to interest rate products being the main derivative instrument traded in 2011, accounting for RM415.0 billion or 89% of total trading activities. The main interest rate derivatives traded were the over-the-counter (OTC) interest rate swaps (IRS), registering trades of RM247.9 billion compared to RM178.4 billion in 2010. Activities in the market were heavily dominated by the evolving interest rate expectations that were driven mainly by global market developments. Earlier in the year, the Middle East conflict and higher oil prices led to higher inflationary expectations and investors sought protection by buying IRS (pay fix, receive floating). IRS rates trended higher, giving signals of a tightening cycle. This trend reversed with the Japanese tsunami in mid-March, and medium term (3 yr and 5 yr) IRS rates dipped and remained range-bound even after the OPR hike in May. As financial markets took a turn for the worse in early August due to the US debt ceiling crisis and the escalation of the European debt crisis, there was heavy selling in the medium term IRS and a sharp fall in rates across the entire IRS curve. The lower IRS rates reflected investors’ concerns on the bleak global economic outlook which would prompt central banks to cut policy rates. However, rates were seen stabilizing since November 2011 as European government and regulatory authorities pledged their commitments to address the crisis easing investors’ fears.

Chart 23: IRS Curve

MYR IRS

3.00

3.25

3.50

3.75

4.00

4.25

4.50

4.75

5.00

5.25

5.50

Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Source: Bloomberg

4 Excludes FX related transactions

10 yr

5 yr

3 yr

22

Meanwhile the exchange traded KLIBOR futures recorded a marginal increase of 2.9%, totaling RM161.7 billion. Apart from interest rate derivatives, several interbank players also traded credit default swaps (CDS), equity options and commodity derivatives, with trades amounting to RM3.0 billion, RM2.2 billion and RM3.5 billion respectively. Despite the low volume of trades in these derivatives, this was a sizable increase of 23.6% compared to 2010.

Table 4: Derivatives Trading Volume

INSTRUMENT 2011 (RM bil) 2010 (RM bil) %

IRS 247.9 178.4 +39.0

KLIBOR futures 161.7 157.1 +2.9

Options 5.5 5.2 +5.8

CDS 3.0 2.4 +25.0

Equity Options 2.2 3.3 -33.3

Commodity derivatives 3.5 1.3 +169.2

Others 37.0 21.2 +74.5

Total 460.8 368.9

Source: Market Survey

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DISCLOSURE & DISCLAIMER

This report is written by the Monetary Policy Implementation team from Investment and Financial Operations Department, Bank Negara Malaysia. The views expressed in the report are solely individual and do not represent the views of the Bank at large. The report is general in nature and has been prepared for information purposes only. The information contained in this report is prepared from data believed to be correct and reliable at the time of issue of this report. Neither Bank Negara Malaysia nor any of its affiliates nor its related persons shall be liable in any manner whatsoever for any consequences of any reliance thereon or usage thereof.