Tag Archives: Sukuk

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.

Read the rest …

Sukuk: Issues and the Way Forward

Sukuk: Issues and the Way Forward

sukuk

Sukuk represents a new development in global capital market. It is one of the
fastest growing sectors in Islamic finance and is considered by many as the most
innovative product of Islamic finance.

As a relatively young asset class in the global capital market, the sukuk market
inevitably faces problems typical of its early stage of development. In this relation, some Muslim scholars have questioned its level of compliance with the Shariah law, particularly on how they are structured. The main criticism was from Sheikh Muhammad Taqi Usmani1, a prominent scholar who has taken the view that 85% of the current structures of Gulf sukuk do not comply with Islamic law2, in particular Sukuk Al Musharaka, Sukuk Al Mudaraba and Sukuk Al Istithmar.

Following that, the Shariah Board of Accounting and Auditing Organization for
Islamic Financial Institutions (“AAOIFI”) had studied the subject of the issuance of sukuk in three sessions between 2007 and 2008. After considering the deliberations in these meetings and reviewing of the papers and studies presented therein, the Shariah Board of AAOIFI issued its resolutions in February 2008 to highlight the various areas in sukuk which were found to be non-Shariah compliant. Accordingly, Islamic financial institutions had been advised to adhere to the principles set out in the relevant AAOIFI Standards in sukuk issuance.

This paper attempts to explore the controversies or issues surrounding sukuk, in particular the observations and resolutions issued by the Shariah Board of AAOIFI.

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Sukuk: Issues and the Way Forward