Sukuk; Islamic investing; faith and finance; Sunrise Equities' collapse

The sukuk market slowdown is more a case of a liquidity issue and was not created by the AAOIFI Shari'ah board ruling, according to Islamic finance professionals in the GCC.

Gerald Al-Fil, a reporter in the GCC, describes the reasons that Shari'ah-compliant indices have outperformed the market as a whole, as well as some pitfalls like being overconcentrated in certain sectors like basic materials.

The recent al-salam sukuk from the Central Bank of Bahrain was only slightly oversubscribed, compared with issues last year which were many times oversubscribed. Malaysia may issue a second sovereign sukuk. S&P credit analyst Mohamed Damak discusses the potential for sukuk issues coming out of Africa.

The Times has a lengthy comment on the role of money and interest in the three large monotheistic faiths, Christianity, Islam and Judaism.

Sunrise Equities, an Islamic finance company in Chicago, collapsed recently and the CEO Salman Ibrahim, disappeared leaving the clients and investors in the firm with losses of $50 million.

Is Islamic finance linked with conventional finance?

A few recent articles predict that one of the few winners from the credit crisis will be Islamic finance. This presumption is based on the assumption that the underlying restrictions from the Shari'ah force a more conservative approach to financial services that can restrain the speculative excess that has caused so much harm in the conventional financial system. To a degree, this is true and provide a methodology for a more conservative approach to finance that has greater appeal in a climate of significant deleveraging across the financial markets. However, there remains a link between conventional and Islamic finance that creates some limitations on how much Islamic finance can gain from the problem in the conventional financial industry. To wit, Islamic finance uses LIBOR and other interbank interest rates as a way to price Shari'ah-compliant products and therefore any disruption in the LIBOR market can spill over into the Islamic finance market by raising the cost of Shari'ah-compliant products which are benchmarked to LIBOR or another interest rate. It is unlikely that the Islamic financial market will ever be de-linked from conventional financial markets and it is uncertain whether this is a desirable goal.

The Moroccan government is planning on allowing Islamic banks to operate within the country according to the head of the country's central bank.

Despite a weak credit market globally, Indonesia is still planning the US dollar-denominated sovereign sukuk issue for later this year, followed in the first half of 2009 by a retail sukuk.

The number of Islamic financial institutions in Kuwait surpasses the number of conventional financial institutions, although Islamic financial institutions' total assets is still lower than conventional financial institutions' total assets.

Dubai Bank, an Islamic bank, will issue up to $5 billion in sukuk between now and 2013 starting with an issuance of about $500 million in the next few months to finance its growth. The structure of the bonds will be ijara and musharaka.

State-owned Islamic Bank of Thailand plans to issue sukuk to attract money from the GCC to fund infrastructure projects.

Shari'ah risk, the credit crunch, falls in sukuk issuance

Another article discussing the controversy surrounding the ruling by AAOIFI on the repurchase agreements contained in many sukuk also brings up another as yet unexperienced risk: default. Until now, the focus was on 'Shari'ah risk' of which the AAOIFI ruling was the most striking example. It essentially ruled that a common form of ijara sukuk containing the repurchase of the underlying asset at par which was approved by Shari'ah boards was no longer Shari'ah-compliant.

Different people within the Islamic finance industry have different views on whether the Islamic finance industry has been and can be moving towards standardization. I believe some degree of standardization is necessary, for no other reason than it would help address the shortage of Shari'ah scholars for the time being until there is a less dire shortage of scholars. Khalid Howladar, a senior credit officer at Moody's, believes that Shari'ah-compliance will not necessary become standardized, nor should it, since the most important factor for Shari'ah-compliance is not form, but the intention behind the transaction.

The credit crunch has had a significant impact on the Islamic finance industry and represents part of the cause of the fall in sukuk issuance. Other products, like Amiri Capital's "Shariah fund of hedge funds", are delayed. Amiri's launch is delayed because their prime broker, Lehman Brothers, is now bankrupt and mostly sold off to Barclay's and Nomura.

A Shari'ah scholar, Mohammad Akram Laldin, raised the prospect of new controversy about Shari'ah-compliance by criticizing products that merely mimic conventional finance products. Speaking to Reuters, he remarked, "People tend to, to a certain extent, dilute some of the principles or objectives of certain contracts in order to accommodate conventional features".

The Islamic Bank of Britain released its first half 2008 financial results showing a smaller loss than during the current period caused by the launch of several products.

The G8 countries continue to race towards being the first to issue a sovereign sukuk.

Dubai Group, a conglomerate of companies, wants the Dubai International Financial Centre (DIFC) to become a center of Islamic finance.

The Central Bank of Bahrain sukuk al-ijara was oversubscribed by 120%.

Doha Bank still planning renewable energy sukuk, the future of Shari'ah-compliant ETFs

Doha Bank still plans to issue a $1 billion sukuk to finance a GCC carbon trading market and other renewable energy investments like solar, although it continues to be delayed by turmoil in the global credit markets.

IndexUniverse.com discusses the potential for Shari'ah-compliant ETFs and compares the performance of the underlying MSCI World and MSCI World Islamic, as well as comparing the sector allocations of the two indices. There are ETFs tracking other indices and I think that the results would come out similar: Shari'ah-screened indices performed better than unscreened indices since the beginning of 2007; Shari'ah screens lead to overweighting in energy, materials and healthcare and underweighing in financials. The article goes on to discuss the future of Shari'ah-compliant which appears bright but still a little ways in the distance.

An article on what Mauritius needs to do to develop a more prominent place in the Islamic financial industry also includes a good description of the development of Islamic finance in Africa. Another article, focusing on the Islamic finance industry in Kenya, has a short discussion on Shari'ah-compliant securitization.

The U.K. paper the Times describes the growth in Islamic finance in Britain both among Muslims and non-Muslims.

More sukuk details, Malaysian High Court challenges BBA

The reports that sukuk issuance fell significantly in the first half of 2008 continue to slice and dice the details of changes within the market for sukuk. A recent report from the Islamic Finance Information Service (IFIS) shows that in addition to a fall in issuance by 54% in the first half of 2008 compared with the same period in 2007, the issuance of sukuk are coming more from the GCC, denominated in local currencies, particularly the UAE dirham, and are significantly smaller than older sukuk. Highlights from the report include:

• 61 (valued at $11.55 billion) in H12008 versus 111 ($25.0 billion) in the same period in 2007 and 77 ($13.67 billion) in H12006;
•More sukuk were issued in the GCC than in southeast Asia and the Malaysian Ringgit fell behind the UAE dirham, albeit only slightly, as the currency of choice for issuers;
• In the first half of 2008, only 2 sukuk were issued for more than $1 billion compared with 14 during the full year 2007. Most sukuk in the GCC were greater than $100 million, while Malaysian issues tend to be smaller than $100 million.

The Malaysian High Court ruled that a common product used for home finance, al-bai' bithamen ajil (BBA), is not Shari'ah-compliant and therefore contrary to the country's Islamic banking law passed in 1983. The BBA transaction involves the sale to the bank at par with a resale back to the customer with a deferred repayment. The criticism of the BBA by the High Court was that the sale involved in the transaction was not a 'true sale' but was merely conducted to create a financing activity. There was some disagreement between industry players and academics about whether this ruling would force the restructuring of BBA home finance products. The use of Shari'ah standards that are more liberal than in the GCC has hampered the ability of Malaysia to internationalize its Islamic finance industry as much as other countries. This High Court ruling may be an attempt to force the domestic Islamic finance industry to adopt more conservative standards to better place Malaysia for growth within southeast Asia as countries seem to be adopting more conservative GCC Shari'ah standards.

Diversification of assets and liabilities continues to pose a significant problem for Islamic banks. There are not enough Shari'ah-compliant assets available to diversify to mitigate risk from over-concentration in one asset class and geography.

There is a special feature in MEED on Islamic finance. In the introductory article, MEED writes: "In the first seven months of 2008, $73bn worth of sukuk were issued worldwide" citing a Standard & Poors report. The report showed $14 billion in sukuk through the first eight months of 2008 (through August 31, 2008). The remainder of the article was behind the subscriber wall, so I was not able to see whether there were additional mistakes in the rest of the special report.

The Academy for International Modern Studies, a research & educational body associated with the UK government, will offer its programs in Nigeria.

Indonesia, France need regulatory/tax changes to see growth in the next couple years in Islamic finance

Badlisyah Abdul Ghani, the CEO of Malaysian bank CIMB Islamic, writes in an opinion piece in the Jakarta Times, "The government's proposed issuing of rupiah and U.S. dollar sukuk are anticipated to provide a good benchmark for the Islamic debt capital market. With this benchmark in place, more corporations will be enticed to issue their own sukuk. To facilitate this, the government needs to develop a corporate sukuk law and the relevant Islamic securities guidelines." In addition he highlights the need to change tax laws to ensure "tax neutrality and transaction cost neutrality vis-a-vis conventional bonds".

Anouar Hassoune of Moody's writes about the future of Islamic finance at CPIfinancial. He discusses Islamic financial institutions and internationalization and consolidation, sukuk and the possibility to see an Islamic bank and a sovereign sukuk issue in France in the next two or three years if developments on the legal and regulatory side continue to progress.

A recent sukuk was issued in Abu Dhabi that securitized the receivables in an installment sale of property. It sounds like this creates a securitized murabaha transaction which appears to me to be difficult since the cash flow from a murabaha transaction does not represent a transfer in ownership of the underlying asset. The transfer of ownership in an asset (i.e. trade) is often the fundamental requirement for a transaction to be Shari'ah-compliant. Instead, from what is being reported, the sukuk will be a mudaraba where the sukuk holders are the rabb ul-mal (provider of capital) and the issuing company is the mudarib responsible for executing the business, in this case by collecting payments on land sales and selling any repossessed land. The profits from this will be shared between the issuer and sukuk holders. A Zawya story describes the methodology of the ratings agencies of the sukuk. IFLR describes the structure as well as why it is preferable to many other types of sukuk.

The continuing financial and economic problems in the West are leading to the growth in interest in Asia including through Shari'ah-compliant funds.

Brunei issued its 18th ijara sukuk of B$45 ($32.25 million) million bringing the total it has issued to B$1.2 billion ($862 million). The oil-rich sultanate does not need to issue any debt, but wants to encourage the growth of Islamic finance.

Sukuk no longer primarily denominated in US dollars

One of the findings in the recent Standard & Poors report on sukuk is that the US Dollar is no longer one of the top currencies for new sukuk to be denominated in. The top two, according to S&P, are the UAE dirham (35.5%) followed by the Malaysian ringgit (33.2%, mostly sukuk for the Malaysian domestic market). The US dollar is third with 13.3% followed by the Saudi Arabian riyal with 12.2%. The weakness of the dollar and expectations that other GCC countries would follow Kuwait and end pegging their currency to the US dollar are attributed as the primary cause of this shift from US dollars to UAE dirhams. As the US dollar strengthens, sukuk are expected to be shifted back to dollar denominations, especially since many obligations financed by sukuk are denominated in US dollars.

The rupee-denominated Pakistani government ijara sukuk will mature in three years and be issued for PKR 10 billion ($130 million).

The Islamic Financial Services Board, the Malaysian-based standard-setting body, announced new members which include the financial services regulatory agency from South Korea.

Sukuk: have they been hurt by the AAOIFI ruling?

Frank Kane writes in an opinion column at Emirates Business 24/7 that more clarity is needed in the sukuk market to encourage continued growth. He argues that the recent Bloomberg article (described briefly here last week) claiming that the controversy over the Shari'ah-compliance of ijara sukuk caused a decline in sukuk issuance and prices was not the correct causation. Following Sheikh Usmani's criticism that 85% of GCC sukuk are not Shari'ah-compliant, the AAOIFI Shari'ah-board which Sheikh Usmani chairs met and released a statement on repurchase agreements that added some clarity to the issue. More likely, the spillover from the credit crisis is more likely the cause of the slowdown.

In an update to the Bloomberg story, the total sukuk issuance through August 31, 2008 was $14 billion compared with $23 billion in the same period in 2007 according to Standard & Poors.

Qatar National Bank, which had a representative office in Singapore has converted this into a full branch. QNB has a wholesale banking license in the country. Singapore has worked to catch up with other countries in Southeast Asia at attracting Islamic finance. One area where other countries and city-states can compete with Malaysia, which has a large advantage in Islamic finance industry development, is working internationally, particularly with the GCC region. Malaysia has led the region on Islamic finance but this development has been largely for the domestic market and the more liberal Shari'ah standards have made its expansion internationally more difficult, particularly in regions with more conservative interpretations of Shari'ah-compliance.

Islamic banking in India, sukuk fund, QIB may list shares of its subsidiaries

The head of a cooperative credit society in India discusses the potential benefits from the development of Islamic banking in the country. A recent report, the Rajan Report, endorsed the idea of promoting Islamic banking in India.

Two GCC-based firms, Algebra Capital and Elaf Bank, are launching a $100 million sukuk fund.

Qatar Islamic Bank may list shares in its international subsidiaries when they reach an "appropriate scale" according to the CEO Salah Jaidah.

Economist articles on two primary challenges in Islamic finance; Pakistan sukuk; Islamic banking in India - the Rajan Report

The Economist turns its eye towards Islamic finance in an article that, in addition to describing Islamic finance, highlights two significant dilemmnas in Islamic finance:

1) How to balance innovation versus authenticity (the subject of the Harvard Forum on Islamic Finance this past April at which I presented a paper on microfinance) and
2) The liquidity problem with Islamic banks created by reliance on short-term depositor funding (liability side of the balance sheet) while holding long-term assets.

. The Economist describes them each:

1) "The AAOIFI ruling on sukuk earlier this year neatly captured the contradictory pressures on the industry. On the one hand, bankers are worried that the narrow enforcement of sharia standards is liable to stifle growth; on the other some observers fear that Islamic finance is becoming so keen to drum up business that its products, with all their ingenuity, are designed to evade strict sharia standards."
2) "Islamic banks depend on short-term deposit funding, which, as Western banks know all too well, can disappear very rapidly. “Lots of assets are generally of longer term than most deposits,” says Khairul Nizam of AAOIFI. “Banks have to manage this funding gap carefully.” If there were a liquidity freeze like the one that struck Western banks a year ago, insiders say that the damage among Islamic banks would be greater. "

The Economist also provides a brief overview of the development of Islamic finance.

Pakistan plans to launch its first sukuk in the first week of Ramadan (August 31-September 6), according to Central Bank governor Dr Shamshad Akhtar. Given that it is September 5th today, the timeline for the ijara sukuk issue appears very tight and likely will be the announcement of a timeline and not include much substantive details relating to the eventual issue.

A committee studying the financial industry in India headed by former IMF chief economist Raghuran Rajan is expected to advocate the development of Islamic banking to reduce the marginalization of Muslims in the country's financial industry. It is also expected to promote the development of equity-based microfinance products for Muslim clients who want to avoid interest-based microfinance. One member of the panel, the chairman of microfinance institution Basix, Vijay Mahajan said "We have recommended that micro-equity financing as a product should be included in mainstream banking. All banks and microfinance institutions should offer these micro-equity financing products"

Sukuk rising or falling?

Juhaina Kasimali at Zawya provides a comprehensive overview of the sukuk market. Haris Anwar at Bloomberg describes the fallout from the controversy about repurchase agreements in ijara sukuk. There was only $11 billion in sukuk issued through August compared with $21 billion in 2007. Prices have also declined in the secondary market.

London continues to lead Western countries in the size of its Islamic finance industry. The UK is the only Western country on the IFSL global ranking of Sharia-compliant assets by country at 10. The UK also has one of the most robust, although still small, secondary market for sukuk with trading volumes of $2 billion. The time frame for the volume number was not specified but I would assume it is for last year because the total issues of sukuk in 2007 was $38.6 billion worldwide and fewer than ten are listed on the London Stock Exchange.

Many lawyers working on Islamic finance are moving to the GCC.

The most recent Central Bank of Bahrain salam sukuk was again oversubscribed, but by less than previous issues. This issue received subscriptions of BD7 million for the BD6 million issue while last month, BD13 million in subscriptions were received for the same size issue.

Islamic finance & microfinance, law firms see need for Islamic finance expertise

John Foster comments regarding Ramadan touch on the idea that GCC-based Islamic financial institutions could make a huge difference in reducing poverty if they devoted a fraction of their resources to helping provide financial services to the poor in nearby countries in Asia and Africa.

The head of global strategy for Reed Smith L.L.P., a law firm based in Pittsburg, Pennsylvania, responds to a question about why they feel they need to have expertise in Islamic finance.

Q: Do you have an Islamic finance practice?
A: We do have some Islamic finance work out of Dubai and Abu Dhabi. It is increasingly important because that is where the money is. Let's face it: Money is basically pouring into the Middle East and, to the extent that it is going to be invested in debt instruments, it will have to be in instruments that are sharia [the Islamic legal code] compliant, and you have to have expertise to do that.

DIFC Authority CEO Nasser Al Shaali says that Islamic finance is providing one of the driving forces attracting "new, more sophisticated investors".

La Trobe University in Sydney, Australia launched the country's first master's degree in Islamic commerce.