Tag Archives: Sukuk

Ernst & Young projects mixed outlook for the Islamic finance industry

Ernst & Young projects mixed outlook for the Islamic finance industry

Islamic financial institutions are at cross roads entering 2011, said Ernst & Young. The industry is expected to continue to show resilience in the face of a challenging economic scenario. This is despite the fact that growth levels of the Islamic finance industry, at more than 20 per cent per annum for the past several years, came under tremendous pressure in 2010.

Ashar Nazim, Executive Director and MENA Head of Islamic Financial Services Group at Ernst & Young says: “Having achieved the critical volume estimated at US$1 trillion in Islamic assets, the question reverberating across board rooms, and among users of Islamic financial services, is about differentiation, or the lack thereof, that Islamic financial institutions have on offer.  Effectiveness of the existing Shari’a governance framework, as well as synthetic product structures commonly in use are especially under discussion.”

No longer business as usual

Scarcity of data and under-investment in analytical tools means that Islamic banks’ focus remains limited to a handful of asset classes while their operating costs are, in many cases, higher than their conventional peers. Future opportunities may no longer come from traditional captive clientele. Instead, Islamic financial institutions urgently need to upgrade their business models to tap mainstream segments.

Ashar Nazim added: “Decision makers at Islamic financial institutions need research and tools to assist in making informed decisions on the future growth trajectory of their businesses. Implications of Shari’a rulings on governance, product structures and markets need to be appropriately incorporated at the planning phase itself.”

Ernst & Young was voted the Best Islamic Advisory Firm and also won the award for Best Islamic Research at the 2010 Islamic Business and Finance Awards organized by CPI Financial. Ernst & Young’s Islamic Financial Services team was acknowledged for its original thought leadership to help steer the industry through the difficult business environment.

Ernst & Young also recently joined hands with AAOIFI*, the leading standard-setting body for Islamic finance industry, to provide product and contract certification that would strengthen universal acceptability of Shari’a compliant products offered by Islamic financial institutions.

New direction for the industry

Ernst & Young’s World Takaful Report highlighted the fluid nature of the takaful industry, as well as tremendous growth potential. The industry is expected to grow three-fold from an estimated US$9 billion in 2009 to $25 billion by 2015. “The biggest challenge for the takaful operators is to bring out the differentiation, its unique Islamic proposition, for its stakeholders. This was the key message for the industry during 2010,” said Ashar.

Ernst & Young’s Islamic Funds and Investment Report 2010 confirmed that more than half the Islamic fund managers may be operating with less than the minimum assets under management needed to remain viable. The opportunity is for global fund managers as well as for consolidation within the industry. Islamic endowment, or Waqf, with an estimated US$105 billion wealth pool, was highlighted as a key emerging sector that could potentially stimulate strong liability generation for Islamic banks, as well as help revive the Islamic fund management industry.

Source: http://www.zawya.com/story.cfm/sidZAWYA20110109091715

Yemen Plans First Sukuk Offering to Fund Budget Deficit

Yemen Plans First Sukuk Offering to Fund Budget Deficit

Yemen, the poorest country in the Middle East, plans to sell $500 million of local currency Islamic bonds for the first time to fund the budget deficit and spur the Shariah-compliant finance industry.

The central bank may offer sukuk in the domestic market from the first quarter, Deputy Finance Minister Jalal Yaqoub said in a telephone interview Dec. 29 from Sanaa, the capital. The government is seeking technical assistance on the sale from the International Monetary Fund.Tadhamon International Islamic Bank, the largest Islamic bank in Yemen, and Cooperative & Agricultural Credit Bank said they will participate in the sale.

“The issuance of the sukuk will create investment opportunities and diversify banks’ portfolios, both Islamic and conventional banks,” Masood Ahmed, director of the IMF’s Middle East and Central Asia Department, said in a telephone interview from Washington Jan. 4. “It will help the government to diversify the sources of budget financing.”

Yemen, which is battling al-Qaeda, an uprising in the north and a secessionist movement in the south, needs funds to bridge its fiscal gap, the biggest on the Arabian Peninsula. Muslims make up the majority of the population of 23.5 million, according to the Central Intelligence Agency World Factbook. Growth in the $30 billion economy will slow to 4.1 percent this year, from 8 percent in 2010, the IMF said in its October Regional Economic Outlook report.

Financing Deficits

The government’s 1.84 trillion-rial ($8.6 billion) budget for 2011 forecasts a deficit of 316.4 billion rials, state-run news agency Saba said Dec. 29. The government plans to fund the gap through domestic borrowing including sales of Islamic bonds and from external loans such as a three-year, $369.8-million credit facility from the IMF, according to the organization.

Foreign debt rose to $6.49 billion last September from about $6 billion a year earlier, Saba news agency reported Dec. 29, citing a central bank report. Yemen received a total of $808 million in loans from the Arab Monetary Fund, a unit of the 22- member Arab League, the fund said Dec. 26 on its website.

Yemen’s proposed Islamic notes will target individual investors and local banks, the Finance Ministry’s Yaqoub said. The government will determine sale details by the end of the first week of February, he said. The central bank currently sells 91-day, 182-day and 364-day treasury bills, according to data on its website.

Savings

“Yemeni citizens have a reasonable amount of savings, but the funds haven’t been used in projects,” Yaqoub said. “We want the savings that go to the Islamic banks to go to big development projects like electricity, roads, water and schools.”

Other governments are also seeking to benefit from growing interest in Islamic finance.Afghanistan drafted an Islamic banking law to permit standalone Shariah-compliant banks,Sudan sold Islamic bonds to local banks last month and the Palestinian Authority plans to sell its first sukuk this year. Global assets held by Islamic financial institutions may climb to $1.6 trillion in 2012 from about $1 trillion, the body said in April.

Shariah-compliant bonds returned 12.8 percent last year, the HSBC/NASDAQ Dubai US Dollar Sukuk Index shows. Debt in emerging markets gained 12.2 percent, according to JPMorgan Chase & Co.’s EMBI Global Diversified Index.

Global sales of sukuk, which pay returns based on asset flows, dropped 15 percent to $17.1 billion in 2010, according to data compiled by Bloomberg.

Sukuk Investments

The yield on Malaysia’s 3.928 percent Islamic note due June 2015 fell 9 basis points to 3.02 percent today, according to Royal Bank of Scotland Plc prices. The extra yield investors demand to hold Dubai’s government sukuk rather than Malaysia’s was little changed at 319 basis points, according to data compiled by Bloomberg.

The difference between the average yield for emerging market sukuk and the London interbank offered rate narrowed six basis points to 284 yesterday, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index.

Yemen has 17 banks, including three Islamic banks, Saba Islamic Bank, Tadhamon International Islamic Bank and Islamic Bank of Yemen for Finance and Investment, according to central bank data. Islamic banks in the country have “ample liquidity for an instrument like a sukuk,” which will help spur demand, the IMF’s Ahmed said.

Needing Sukuk

Sanaa-based Cooperative & Agricultural Credit Bank will buy the bonds to diversify holdings, economic and investment adviser Moneer Saif said in a telephone interview Jan. 5 from the capital. The bank’s Shariah-compliant unit CAC Islamic is seeking a license from the central bank, he said.

“Of course we will buy,” Saif said. “It will be one of our priorities. Islamic banks need Islamic products as an alternative to achieve good profits and compete with conventional banks.”

Oil accounts for 60 percent of government revenue and 90 percent of exports, the IMF said in a report on Aug. 19. Oil reserves are expected to be depleted within a decade, the Washington-based lender said.

U.S. pressure on Yemen to crack down on al-Qaeda has intensified since the local wing of the group claimed responsibility for a failed attempt to blow up a U.S. airliner on Dec. 25, 2009. In October, two parcel bombs sent from the country to U.S. synagogues were seized in the U.K. and Dubai.

The country’s economic “challenges are compounded by a difficult security situation and civil unrest, a rapidly growing population, poor infrastructure, and weak institutional capacity,” the IMF said.

‘Failure’

The government’s plan to finance infrastructure with Shariah-compliant funds may not succeed because existing electricity and water projects are “already a failure,” Rasheed al-Sakkaf, head of treasury at Tadhamon International Islamic Bank, said in a telephone interview Jan. 3.

Al-Sakkaf said his bank would only buy if the project is economically viable. “If the profit is good, we will buy more.”

Islamic bonds are typically backed by assets or cash flow because of the ban on interest. Investors earn any profit from the assets instead.

Yemen delayed the sukuk sale from last year because the government had difficulties “getting well-skilled staff to run the sukuk project,” Yaqoub said.

The 15 percent increase in oil prices last year, economic growth and a recovery in the rial have set the stage for a sukuk offering this year, the IMF’s Ahmed said. The currency has gained 12 percent since reaching a 2010 low of 239.98 on Aug. 4, according to data compiled by Bloomberg.

“The conditions should be there for them to be able to diversify their domestic debt instruments by introducing their sukuk in the market,” he said.

Source: http://www.bloomberg.com/news/2011-01-05/yemen-plans-first-sukuk-offering-to-fund-budget-deficit-islamic-finance.html

To contact the reporter on this story: Dana El Baltaji in Dubai delbaltaji@bloomberg.net

To contact the editor responsible for this story: Claudia Maedler at cmaedler@bloomberg.net

Controlling Fatwa would harm Islamic Finance (Reuters)

Controlling Fatwa would harm Islamic Finance (Reuters) — Straightway Ethical Advisory Blog

 

 

Recent developments in the Islamic finance market prompted the industry to rethink the role of Shariah scholars.

Most Islamic financial institutions appoint a supervisory board or committee of religious scholars who are tasked with reviewing their transactions in order to ensure that they comply with the principles of Islamic Shariah in their business and financial dealings.

A Shariah supervisory board or committee approves or rejects a transaction through the issuance of a fatwa (an opinion or proclamation about the Shariah compliance of such a transaction).

The question of the day in the Islamic finance industry is whether Shariah scholars should be subject to some sort of supervision themselves.
In our opinion, the answer to this question depends on what is meant by ‘supervision’.

Industry practitioners should oppose supervision if it means that Shariah scholars would have to adhere to strict criteria or methodology before issuing a fatwa. Such supervision would in our opinion curtail innovation and transform the industry, prematurely, to a commoditised industry, since Shariah scholars would in their attempt to check all the boxes and stay within the accepted norms, refrain from covering new ground and developing new structures that would allow new transactions and thus the development of the industry.

The industry should not lose sight of the fact that Shariah scholars are our current day mujtahid (jurist). Throughout the history of Islamic jurisprudence, the use of human reasoning (ra’y) has played an important part in the development of Islamic Shariah.

When issuing fatwa, Shariah scholars are practising ijtihad and they should enjoy complete freedom in their practice of ijtihad; their guidance and limitations should only come from the five sources of Islamic Shariah being: the Qur’an; Sunna (the practice and traditions of the Prophet Muhammad (peace be upon him); Qiyas (a comparison, used to make a judgement on issues which have no clear-cut ruling in the Qur’an or the Sunna, by consideration of similar issues which do have clear ruling); Ijtehad (the diligent judgement of the scholars through reasoning and logic); and Ijmaa (a consensus or agreement used for issues which require Ijtehad).

Therefore, in our opinion, Shariah scholars should not be restricted or limited in their practice of ijtihad by any regulator. Such regulation would neither benefit the Shariah -compliance of the industry nor its further development.

However, we would support supervision of Shariah scholars such as the new proposed rules of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) to reduce the risks of conflicts of interest or improper disclosure.

This type of supervision may lead to more transparency and benefit the authenticity and credibility of both the industry and the Shariah scholars. Organisations such as the AAOIFI should run training and continuing education programs for would-be Shariah scholars. Such programmes should aim to provide Shariah scholars with an understanding of various financial and business transactions and the legal framework in which such transactions are being consummated.

Most importantly, these training and continuing education courses should train Shariah scholars to be inquisitorial of the intention (niyya’) behind the transaction.

Ethica and Zawya Announce Partnership

Ethica and Zawya Announce Partnership

DUBAI, UAE, September 20, 2010 /PRNewswire/ — Ethica Institute of Islamic Finance and Zawya today announced a partnership to jointly deliver online Islamic banking courses and certification. Ethica Institute’s certification is chosen by more professionals and students than any other Islamic finance certificate in the world, and Zawya is widely regarded as the leading provider of business and investment intelligence in the Middle East.

“We are very excited to partner with Zawya to offer their community of business professionals, nearly 1 million visitors per month, with online Islamic finance training and certification,” said Ethica’s Managing Director, Atif Khan. “This historic partnership addresses the greatest need in the industry: practical training developed by scholars and bankers and delivered online around the globe; rather than theoretical training taught by academics and delivered inside a classroom.”

Zawya’s acting Chief Executive Officer, Gunnar Skoog, said, “This landmark partnership with Ethica marks Zawya’s ambition to provide quality training and certification in Islamic finance. It will enable us to provide a one-stop platform for Sukuk news, reports, intelligence, connectivity and education developed by scholars and bankers.”

A partnership between Ethica and Zawya would bring unprecedented access to standardized Islamic finance training and certification to both companies’ extensive community of high-end users. In the coming months the two companies intend to jointly launch a specialized Islamic finance certification focusing on Sukuk.

Ethica Institute of Islamic Finance (http://www.EthicaInstitute.com) trains and certifies professionals and students in Islamic finance online and at its training facilities in Dubai.

Headquartered in Dubai with sales and support offices throughout the Middle East, Zawya (http://www.Zawya.com) is the leading provider of business and investment information serving high-end professionals focusing on the region.

Sameer Hasan, Business Director, http://www.EthicaInstitute.com, Office: +9714-305-0782

SOURCE: Ethica Institute Of Islamic Finance

Original Press release available here: http://www.prnewswire.com/news-releases/ethica-and-zawya-announce-partnership-103256839.html

Islamic rate of return: the new IRR

Islamic rate of return: the new IRR

The issue is discussed by Joseph DiVanna, MD of Maris Strategies, a Cambridge-based strategy think tank for financial services specialising in economic, demographic and consumer intelligence in emerging markets.

Islamic finance is poised for a significant surge as world markets reorganise and Shari’ah-compliant banks reassess their position in local markets. As a global market, Islamic banking has grown at an impressive 27 per cent per annum over the past five years, and is estimated to reach $1 trillion in 2010. Growth in the Islamic finance industry will occur along three distinct fronts: organic growth, new market growth and product growth. Organic growth will continue as Shari’ah-compliant banks persist in engaging their clients with additional services (aiming to increase deposits). New market growth will consistently rise as more banks are engaging previously unbanked populations in Africa, the Middle East and Southern Asia where the ratio of people banked is very low. It is however the third area of product growth which holds the most long-term benefits for Islamic finance.

Shari’ah-compliant institutions are emerging from 2009 with a renewed sense of confidence as the impact of the financial crisis is passing from a panicked search for guilty parties to a refocused approach to risk management. Islamic banks have been somewhat insulated from the global financial crisis because of their lack of access to what is now labelled as ‘toxic assets’. What Islamic banks have noticed during the crisis is a steady increase in assets as investors/depositors take conservative postures and a marked reduction in the generation of fee and investment income. Unlike their conventional counterparts, during 2008-09 Shari’ah-compliant institutions continued a deliberate plan of innovation, mainly in retail banking distribution, experimenting with technology. Now these banks are turning their attentions toward a longer-term growth agenda which includes product innovation that is more distinctly a representation of Islamic values and beliefs.

However, the rate at which this potential for growth is achieved is predicated on the establishment of additional national and international financial infrastructure. One key area of discussion is in the use of LIBOR (London Interbank Offered Rate) as an industry benchmark for sukuk and other instruments. Today, the performance of Shari’ah-compliant products such as sukuk are measured (or linked) to LIBOR as a benchmark, not by design, simply as a matter of convenience in the early stage of market development. To compete with conventional banks, which many of their clients have been using for decades, Shari’ah-compliant institutions have adopted the use of LIBOR so customers have a readily recognised mechanism to assess the relative rate of return on their product offerings.

Shari’ah scholars have been divided on the use of LIBOR as it gives the appearance of an interest-like quality to Shari’ah-compliant financial instruments. Conversely, some Islamic scholars have argued that simply using an interest rate as a benchmark for determining the relative rate of return for a Shari’ah-compliant instrument does not render the instrument non-compliant.

‘In the final analysis, a benchmark is no more than a number, and therefore non-objectionable from a Shari’ah perspective. If it is used to determine the rate of repayment on a loan, then it is the interest-bearing loan that will be haram. LIBOR, as a mere benchmark, has nothing to do with the actual transaction or, more specifically, with the creation of revenues or returns,’ says Shaykh Yusuf Talal DeLorenzo, chief Shari’ah officer and board member of Shariah Capital, a US-based Shari’ah advisory firm.

The key point of debate is the appearance of a Shari’ah-compliant financial instrument to generate a fixed rate return. Under Shari’ah principles, money cannot generate money, which in modern times is represented by interest. Numerous Shari’ah scholars have argued that instruments such as murabaha (debt) cannot be securitised, since sukuk-backed pools of murabaha are simply the sale of documents representing money, which can be interpreted as merely trading of monies. On the other hand, Malaysian scholars have argued that if the underlying receivable is associated with a true trade transaction or to a commercial transfer of a non-monetary interest, such a receivable can be traded freely for the purposes of Shari’ah.

Theoretically, a hybrid (debt/equity) sukuk could be structured to emulate a quasi-fixed return found in conventional bonds whereby the LIBOR benchmark would give investors an understanding of the instrument’s return relative to a conventional counterpart. Thus if structured properly the hybrid sukuk can generate a profit-based return that is comparable to a conventional LIBOR-based product. What this boils down to is the fundamental need for the industry to mature to a new level through a process of product/market innovation that increases the depth of market offerings. Market infrastructure such as a Shari’ah-compliant money market instrument, the establishment of a secondary market and secondary market pricing are but a few of challenges in the years to come, which will reach higher levels of discussion in 2010. Islamic rate of return (IRR)

Fundamentally, the industry, or more specifically central banks, must address the creation of a benchmark that represents the cost of capital in Shari’ah-compliant terms. Without a clear Islamic rate of return (IRR) LIBOR will continue to be used. The use of LIBOR and the development of an alternative has been discussed and debated during the past five years resulting in few alternatives. The central issue is the cost of capital and the establishment of an Islamic rate of return for procurement and placement of funds. Some scholars advocate the development of a mechanism similar to a rent index used when working with ijara instruments. Hence the industry will continue to use LIBOR as the only recognised benchmark. That said, the Islamic International Financial Market (IIFM), a Bahrain-based non-profit international infrastructure development institution, identifies several alternative theories:

  • Abbas Mirakhor approach: proposes that the cost of capital be measured without resort to a fixed and predetermined interest rate using equity financing as the source of financial capital (Tobin ‘q’ theory).
  • Sheikh Taqi Usamni approach: a benchmark can be achieved by creating a common pool which invests in asset-backed instruments (e.g. musharakah, ijara) where units can be sold and purchased on the basis of their net asset value determined on a periodic or daily basis.
  • Bank Negara Malaysia (Malaysia’s central bank) approach: proposed in ‘Framework of the Rate of Return’ sometimes referred to as mudarabah interbank investments (MII) – a standard methodology to calculate the distribution of profits and the derivation of the rates of return to depositors. A calculation table prescribes the income and expense items that need to be reported. It also sets out the standard calculation in deriving the net distributable income and a distribution table sets out the distribution of the net distributable income posted from the calculation table among demand, savings and general investment deposits according to their structures, maturities and the pre-agreed profit sharing ratios between the bank and the depositors.

Another alternative, which was introduced in 2004 by the State Bank of Pakistan (SBP) and the Pakistan Banks’ Association (PBA), is the KIBOR (Karachi Interbank Offered Rate) a benchmark for corporate lending in local currency defined as ‘the Average rate, Ask Side, for the relevant tenor, as published on Reuters page KIBOR or as published by the Financial Markets Association of Pakistan in case the Reuters page is unavailable. The banks and the borrowers are free to decide the relevant tenor of KIBOR and the spread over KIBOR at their discretion. KIBOR will be set for the lending facility on the date of drawdown or on the mark-up reset date. The offer letters from the banks to their clients should clearly indicate the KIBOR’s tenor and the agreed spread, frequency of revision’. The six-month KIBOR is most widely used as a benchmark.

How will an Islamic interbank rate work?

One theoretical construct is the use of a mudarabah concept whereby Shari’ah-compliant institutions with excess reserves (surplus banks) can invest in the interbank money market which in turn provides funding to banks looking for funds (deficit banks). Surplus banks act as investors while the central bank acts as an entrepreneur. The parties agree on a profit sharing ratio between the surplus banks (70 per cent) and the central bank (30 per cent). The surplus bank receives 70 per cent profit while the central bank will receive 30 per cent. The profit rate is based on the benchmark calculation of the profit as: profit equals (principal x profit rate x time x profit sharing ratio) divided by 365. Although theoretically, profit rates are acting under a similar means as an interest rate there is a built-in risk associated with the performance of the underlying assets associated with all the transactions initiated by the banks. Clearly, these types of mechanisms are in their infancy and will require a great deal of discussion between Shari’ah scholars, central bankers, monetary policy makers and bankers.

Conclusion

The Islamic finance market will continue to grow and strengthen during 2010. The rate at which the growth will occur is dependent on two things: the development of supporting market infrastructure such as a replacement for LIBOR and the confidence in the bankers themselves to conduct business in challenging economic times. The development of alternative benchmarks demonstrates the rising independence of Islamic finance as a viable alternative to conventional financing. As new economic data slowly reveals the emergence of renewed growth, Islamic finance is poised to enter 2010 as the first year of a new generation of development.

Islamic Finance coming of age: KPMG – Frontiers in Finance

Islamic Finance coming of age: KPMG – Frontiers in Finance

Last year may go down in history as the watershed year for the financial services industry. However, as Dr. John Lee and Anita Menon explain, while Islamic finance was not entirely unscathed by the vagaries of the economy and the contagion effect of the conventional finance sector, the industry still recorded compounded annual growth rates of 28 percent from 2006 to 2009. Islamic banks also recorded an increase in assets by 28.6 percent in 2009 to US$822 billion.1

This in itself is interesting, as a couple of years ago at the height of the previous growth cycle for Islamic finance, many felt that the true test of the resilience of the system would be when there was a shock to the system, and when the liquidity in the Middle East dried up. However, skeptics would also claim that this was due to Islamic institutions general investment prohibitions which meant that they were less exposed to subprime assets.

2009 also saw the entrance of a number of new players which indicate that interest in this burgeoning sector is as yet, unabated. As at end 2009, there were 1,124 Islamic financial institutions globally.2 While issuance of sukuk3 dropped in 2009 on the back of tightening liquidity and concern on possible defaults, the demand for quality sukuks continued to be there and issuance increased by 40 percent for the first 10 months of the year, as compared to the corresponding period in 2008.4 Saudi Arabia led the issuance followed closely by Malaysia; with one of the largest issuances by Malaysia’s national oil and gas company Petronas totaling US$1.5 billion.

Outlook for the rest of this year and into 2011

The outlook for the remainder of 2010 remains positive with some analysts saying5 that Saudi Arabia is expected to continue to lead issuance, although investors are expected to be somewhat spooked by the recent Dubai World crisis, sukuk defaults and the problems seen to be encountered by some of the institutions in the Middle-East. Dar-Al Arkan, Saudi Arabia’s largest property developer by market value, successfully issued a sukuk in February this year raising US$450 million and analysts believe that the number of issuances for the rest of 2010 is likely to grow to pre-crisis levels.

KPMG in Malaysia’s analysis indicates that the Islamic finance market is steadily growing both deeper and wider, with the emergence of new Islamic finance markets such as the Maldives, Korea, Kenya, Nigeria and also stronger interest from EU countries like France and Italy. Korea for instance, is currently working on amendments to its legislation that may see the first Korean sukuk being issued as early as 2010 or 2011. In Malaysia, the interest continues to grow and, among the recent liberalization measures is the issuance of two new Islamic banking licenses to foreign players; with a paid-up capital of at least US$1 billion, along with two family Takaful licenses towards the middle of this year. Malaysia continues to be a leading market outside the Middle East with assets of almost 11 percent of the global market and with Islamic assets making up almost 19 percent of the banking and finance market in Malaysia. However, the UK is emerging as a key market holding close to 2.5 percent of global assets.6

Within the Asia-Pacific region, relative newcomers such as Singapore and Hong Kong have expressed their desire to also become centers, while the most populous Muslim nation – seen by many as the next big growth zone – Indonesia has still a long way to go if estimates of asset size are anything to go by. Bank Indonesia, the central bank of Indonesia, has indicated that shariah assets are projected at US$7.6 billion as at end 2009, which places the nation’s Islamic finance assets at 2-3 percent of the total banking assets.7 This is attributed to the nascent infrastructure and regulatory system for Islamic finance. While there is a new law which was set to be effective in April 2010 that would remove the double-taxation on some Islamic banking transactions, there are still issues around this area that hold back the otherwise huge untapped potential in this country.

The global Muslim population is continuing to grow faster than the non-Muslim market; recent estimates place the Muslim population at 1.57 billion, 23 percent of the global population.8 There is also a large Muslim population in the Asia-Pacific region – China for instance has more Muslims than Syria; while Russia has more Muslims than Jordan and Libya combined. This translates to immense opportunities for shariah compliant finance in as yet untested markets. The potential for Islamic finance continues to be enormous. The only impediment to its growth may be that the conventional regulatory structure is currently unable to support the introduction of Islamic products.

Through the adoption of a progressive face as opposed to an overtly religious tone, in countries such as Malaysia, the Islamic finance industry has continued to make inroads in the non-Muslim market. This may also be the approach adopted in countries such as India and certain African countries with large Muslim populations, but, where the projection of an Islamic face would be anathema to the political regime.

Islamic finance is also gaining acceptance where it is seen as an ethical alternative to the conventional system, bridging the gap between socialism and capitalism. According to the Vatican’s official newspaper Osservatore Romano in its March 2009 issue, “The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service.” Ethical investors also are drawn to the principles that underlie Islamic financial transactions. Therefore growth is expected to come from this segment of consumers as well who are not necessarily attracted by its faith-based appeal, but more from its socially responsible outlook.

The future of Islamic finance

The ongoing debate on whether products are shariah compliant or shariah based and the lack of standardization, continues to be an issue. Additionally, other major hurdles that remain or have become more apparent with the recent financial meltdown include:

  • the need for robust risk management practices that would be able to drive product innovation and development;
  • the need for a legal and regulatory framework for dispute resolution, especially on cross-border transactions;
  • the ongoing requirement for trained practitioners in this field that have a strong understanding of shariah requirements, but are also in tune with market and consumer demands.

Notwithstanding that, many Islamic institutions are expected to undergo a transformation in their approach and strategy, and more importantly in their business models as well. This will enable them to encompass more of the ideals of shariah principles and to move away from the predominance of debt-based structures as in the past. When Islamic finance was first introduced into the market, the approach was to adopt products that were familiar to the generation of consumers and clients brought up on conventional financial products. Therefore, Islamic financial products were shariah compliant mirrors of their conventional equivalents. Furthermore, the initial target market was retail customers who are generally risk-averse and therefore, fixed rate products were more appealing to this segment of the market.

Increasingly however, a radical shift from the current norms will be required and this would fuel the anticipated growth in Islamic finance. The pursuit of social objectives would gain emphasis alongside the pursuit of commercial objectives; since Islamic finance is meant to be the antithesis of the previous conventional financing norms – where excessive risk-taking led to the ultimate downfall of many players. The financial crisis has heightened the interest in Islamic finance and it’s future; the concepts of risk-sharing should be ingrained further through the development of more profit and risk sharing mudaraba and musyaraka products. This would require a shift in banking business models as well. Increased product sophistication and market awareness-building would also need to go hand-in-hand with the advancement of the financial and legal infrastructure.

Over the next 18 months Islamic finance institutions are expected to come of age.

1. Banker’s Top 500 Islamic Financial Institutions survey published in association with HSBC Amanah, www.ameinfo.com/214968.html, November 5, 2009.
2. “The Future of Islamic Finance”, Financial Times Special Report, December 8, 2009.
3. sukuk – an Islamic financial certificate, similar to a board in Western finance, that complies with shariah law.
4. “Moody’s reports: Sukuk issuance surges, dominated by government-related issuers,”Global Credit Research, www.moodys.com, November 10, 2009.
5. “Saudi seen leading 2010 sukuk issuance,” www.reuters.com, February 17, 2010.
6. Banker’s Top 500 Islamic Financial Institutions survey published in association with HSBC Amanah, www.ameinfo.com/214968.html, November 5, 2009.
7. “Indonesia embracing growth Islamic finance,” www.thejakartapost.com, April 5, 2010
8. “Global muslim population hits 1.57 billion,” www.cbsnews.com, October 7, 2009.

Source: KPMG – Frontiers in Finance June 2010

The role of sukuk after recent defaults

The role of sukuk after recent defaults

 

 

 

 

 

 

 

Dubai World is presenting creditors with a restructuring plan for $26bn of debt. Questions remain about how Islamic financial structures will fare in financial distress. Usman Hayat discusses the role of sukuk after recent defaults.

Are sukuk holders treated differently from conventional bondholders in the event of default?
Defaults pertaining to sukuk are a recent phenomenon, and how the underlying legal structures would fare in a court of law vis-à-vis conventional bonds is uncertain. Although sukuk must comply with Islamic law, they are governed as well by the secular law under which they are issued, like bonds. In the case of Dubai World, a last-minute bail-out by Abu Dhabi has obviated the need to address this question directly.

What is the difference between asset-backed and asset-based sukuk?
The key difference is the concept of true sale. In asset-backed sukuk, there is a true sale between the originator and the special purpose vehicle (SPV) that issues the sukuk and sukuk holders do not have recourse to the originator. Assets are owned by the SPV, returns are derived from assets, and asset prices may vary over time. The majority of sukuk issues, however, are not asset backed.

What issues have arisen following recent defaults in sukuk?
One of the most critical issues is whether the SPV—and thus sukuk holders—completely owns the underlying assets. In addition, the role and efficacy of sharia governance arrangements and due diligence for sharia compliance have attracted attention. Given the relatively nascent stage of development of sukuk in particular and of Islamic finance in general, sukuk are likely to continue to evolve.

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