BNI to issue sukuk in Malaysia; Turkey's sukuk "should not be belittled"

PT Bank Negara Indonesia (BNI), the third largest state-owned bank in Indonesia, may issue up to $50 million in sukuk in Malaysia. The issue will depend upon market conditions for sukuk in Malaysia. Many new sukuk issues are likely to depend heavily on the market conditions during 2009. Estimates of sukuk are $4-5 billion for 2009 for Malaysia and Southeast Asia, but I would not be surprised if there were as few as $3 billion (if conditions stay the same or worsten) or as much as $8-$10 billion (if there is a significant recovery in global credit markets, particularly if the price of oil leads to a resumption of funds into the GCC region.

I don't know whether this was in response to my blog post yesterday where I said Turkey's first sukuk 'was a flop' (kidding, my blog isn't that widely read), but the head of Turkey's Capital Market Board said "The demand for the revenue-indexed bonds should not be belittled. For a start, it's a good figure". In part, this is true because the bonds are the first from Turkey, are not explicitly called 'sukuk' and are being launched in a time of unprecedented credit constraint.

Indian-based Benchmark Asset Managment will launch India's first Shari'ah-compliant exchange traded fund (ETF), a passive fund tracking the S&P Nifty Shari'ah Index, an index that tracks 37 Indian stocks accounting for nearly ½ of the market capitalization of the National Stock Exchange.

Shari'ah screens have in the past eliminated many companies that have subsequently went bankrupt amid fraud. One prominent examples are Enron and Worldcom, which were excluded from Shari'ah screened investment portfolios more than a year before it collapsed because it exceeded the allowable debt ratio. I looked at the press release at the inception of the S&P Nifty Shari'ah Index on February 18, 2008 and it included among its largest ten companies Satyam Computer Services. As far as I can tell, it was still included in the index at the time its founder revealed a massive fraud. Although Shari'ah screens can provide additional safety, this demonstrates that they are not always completely effective.

Sukuk volume in 2009: opinions differ

An English online grocery store Ocado received £10 million in financing using Shari'ah-compliant leasing (ijara). Although the transaction is small and uses a relatively simple Islamic finance product, it has significance, I think, because it is the company's first use of Islamic finance and it chose this type of finance because of the "competitive offering" from the Bank of London and the Middle East, a Shari'ah-compliant wholesale bank in the U.K. There are relatively few instances where Western companies chose Islamic finance products based on their price competitiveness (e.g., the $166 million East Cameron Gas Co. sukuk), but there is potential for this to become more common if Shari'ah-compliant banks are able to tap sources of capital and have not been hurt themselves by the credit crisis through the slowing of global growth where health companies find that they can only receive finance from conventional banks at extremely high cost.

According to a poll conducted by Reuters, the amount of sukuk expected to come from Southeast Asia, a region with a large volume of sukuk in recent years, is around $5 billion, far below last year. Most of the issuance is expected to be issued by governments. A previous estimate for Malaysia put the volume from that country at $4 billion for 2009. The GCC region is also expected to see far smaller volume of sukuk with unnamed bankers telling Reuters they expect to see issuance between $4 and $8 billion. Standard & Poor's, however, believes there are $45 billion of sukuk in the pipeline and the number that reach the market in 2009 will depend on whether the market becomes more favorable than it is now.

Other News

• Gatehouse Bank announced a new $1 billion 'Milestone Sukuk' platform and a first issue on the platform that it claims makes the issue of sukuk easier.
  
• Islamic financial institution Arcapita Bank, based in Bahrain and Atlanta, Georgia was downgraded recently, in part because of its 'high leverage'. The high leverage aspect is surprising because Islamic finance is often characterized as putting significant limits on allowable leverage.
  
• Turkey's first sukuk, a revenue-linked bond, was a flop raising only about one-quarter of the planned amount.
  
• Organizers of the 2009 Asia Sukuk Summit, in contrast, believe that countries where Islamic finance is just beginning to become into significance like Jordan, Hong Kong, Singapore and Japan will issue sukuk this year.
  

News Bullets

• Paradigm Mortgage Services is the first company to be selected to offer products from the Islamic Bank of Britain.
• Japan-based Bank of Tokyo-Mitsubishi UFJ wants to take a leadership role in the global Islamic finance market.
  
• Takaful premiums in the GCC are expected to grow fivefold in the next 10 years
  
• The CBB salam sukuk was oversubscribed by over 400%. This is the largest oversubscription I can remember in several months which could indicate the beginning of an unfreezing of the sukuk market.
  

The fall in sukuk in depth, new Islamic bank planned

The IFIS report on sukuk issuance in 2008 is out and it provides a deeper look in the 66% decline in sukuk issuance (with the fourth quarter seeing the lowest quarterly issuance since 2002). One particularly interesting part relates to the idea that Islamic finance was immune from the global credit crisis, which IFIS describes as the Islamic version of the now discredited decoupling theory:

"As the GCC bond market flourished even after the initial impact of the subprime mortgage crisis in 2007, there were those who thought that Islamic finance can withstand this downturn intact due to the nature and features of Islamic banking and finance, and therefore of the sukuk market. This led to some unreasonable expectations for the industry. Some industry observers thought that Islamic finance had successfully separated from global conventional credit markets, which was an Islamic variation on the now debunked decoupling theory. Others claimed that Islamic markets were now mature, independent markets, not related to the price of oil. A third view that was sometimes expressed was that lower leverage and emphasis on holding and selling real, tangible assets will save the industry from the full impact of the subprime crisis and subsequent credit crunch. Essentially, all of the above emphasises the fundamentally different natures of Islamic finance and conventional finance. But the evidence counters this. Sukuk have not done well in the past year. Total issuance in 2008 dropped by 66% compared to 2007, showing no immunity from the global downturn."

As the sukuk market succumbed to the credit crisis, some of the debt finance provided by sukuk was replaced by syndicated lending, according to IFIS.

Despite evidence to the contrary, there are still claims that the Islamic finance system is 'unscathed' by the credit crisis and a belief that if the financial system was structured along the lines of the Islamic financial system, there would not have been a credit crisis.

An un-named Islamic bank with $11 billion will be launched by June despite the challenging market conditions. I would foresee great difficulty for this launch, especially since $10 billion of the initial capital is expected to come from an IPO. The bank's role is compared with that of the European Bank for Reconstruction and Development, which is a regional development bank for Central and Eastern Europe established after the fall of Communism.

Other News

• Malaysia's sukuk market is expected to be $4 billion in 2009 compared with $5.86 billion in 2008, which was already a steep (78%) drop from 2007.
  
• Turkey's government announced a sukuk expected to be issued by the end of January to raise $1.15 billion, called "Rent Certificates" linked to the income at four state-owned enterprises.
  
• There are no Muslim faith based debt counselors in the U.S. because "there is no need for a debt-counseling service company, because a practicing Muslim doesn't subscribe to debt service products, such as credit cards"
  
• Bahrain Islamic Bank report falling profits in the wake of the global credit and economic crisis
  
• An existing bank in London, BLME, is starting a new private bank in the U.K.
  
• Another university in Europe, this one in France, is starting an Islamic finance degree as Paris Europlace, the Paris Financial Center, tries to attract Islamic finance to France
  
• Indonesia may extend the term of its forthcoming retail sukuk from three years to five

Correction: I mentioned the $4 billion in debt that Emaar listed on the London Stock Exchange. Of this amount, the European MTN were conventional debt and $2 billion were sukuk.

Discussion on commodity murabaha, MAS sukuk, Yasaar Media and Islamic finance education

A professor of at INCIEF in Malaysia, the Managing Director of Bank Islam and a lawyer in Dubai with Vinson Elkins LLP discusses whether commodity murabaha are overused in an article from Reuters.

Three task forces will study the effect of the global credit crisis on the Islamic financial industry beginning with the Task Force for Islamic Finance & Global Financial Stability headed by Bank Negara Malaysia governor Dr. Zeti Akhtar Aziz. The three task forces were proposed back in October at an Islamic Development Bank meeting.

A media division of Yasaar, Yasaar Media, has been launched. It will be a "dedicated research and media house that produces independent in-depth reports and analysis of market sectors" according to co-founder Paul McNamara (the other co-founder is Majid Dawood, the founder of Yasaar). Paul McNamara is also one of the co-founders of CPI Financial, which publishes Islamic Business & Finance magazine.

The Monetary Authority of Singapore (MAS), the city-state's central bank, completed its first sukuk. It also announced that regulations were loosened allowing banks in Singapore to engage in murabaha and ijara wa iqtina (lease-to-buy). The MAS Managing Director Heng Swee Keat described it as:

"This sukuk is the Shariah-compliant equivalent of Singapore Government Securities (SGS), and is of the highest credit standing. The sukuk will be given equal regulatory treatment as SGS, such as qualifying as an asset in the computation of capital and liquidity requirements, and as eligible collateral for tapping MAS’ liquidity."

In a speech at the Asian Financial Forum, Hong Kong Chief Executive Donald Tsang said that Hong Kong was opening up to Islamic finance. In addition, he commented on the developments already achieved:

"Islamic finance is an exciting area for us and we are making good progress in establishing a platform for Islamic finance in Hong Kong. [...] For example, our regulators have signed Memoranda of Understanding with the Dubai International Financial Centre Authority and the Dubai Financial Services Authority. This will help to foster mutual co-operation in developing Islamic finance between Hong Kong and Dubai.

In addition, we have seen the launch of a variety of Islamic financial products in the market, such as an Islamic banking window and indexes. An exchangeable Islamic bond, or sukuk, has also been listed on the local stock market. We still have much work to do. [...] A review of our tax law is underway to facilitate the launch of more Shariah-compliant products and put in place a level playing field for sukuk vis-a-vis conventional bonds. Islamic finance is a natural extension of our role as a global financial centre."

The University of Reading becomes the latest to add courses on Islamic finance. The new master's degrees will "explore topics such as the Islamic concept of money, so that students will learn the reasoning behind sharia laws, as well as the technical skills to construct sharia-compliant products."

An article in Asharq Alaswat provides a brief history of the beginning of the Islamic financial industry.

Emaar Properties (through Emaar Finance Ltd and Emaar Sukuk Ltd, respectively) listed a Euro Medium Term Note prospectus of $2 billion of sukuk and a Trust Certificate Programme for $2 billion on the London Stock Exchange.I

Sukuk markets not functioning; some companies are turning to conventional debt

The problems in the sukuk market are forcing companies like Malaysian developer IJM Land, to turn to traditional debt, "shattering earlier beliefs the industry would escape the downturn largely unscathed".

Al Mi'yar

As I mentioned in my last blog post, I have posted a more detailed look at the newest structured product from Deutsche Bank, billed as a platform to issue "tradable Islamic security certificates, which represent ownership in Islamic assets."

Renewable energy sukuk, expectations for 2009, new Zawya.com blog

Singaporean renewable energy company Agni Inc plans on issuing a ringgit-denominated ijara sukuk to test the sukuk market.

South Korea Financial Supervisory Service governor says the country should explore using Islamic finance to attract capital.

Although 2008 was an extremely rough year in the financial markets, including Islamic finance, 2009 should see some recovery although other reports, like the one from Standard & Poor's, predicts the sukuk market will only recover towards the end of 2009.

The Associated Press has an article about the University Islamic Financial Corp. in Ann Arbor, Michigan, which is one of a few Islamic financial institutions in the U.S., and the only one with a Shari'ah-compliant deposit product. An interesting part of the article is that two banks have communicated with the UIFC about helping expand its availability across the U.S. Only one bank, Comerica, is named.

Deutsche Bank launched a new platform they claim will enable Shari'ah-compliant money markets, as well as other securitized products. I have not done enough review of the product, but I would hope to be able to study it a little more and post on my new blog at Zawya.com. This will still be a more frequently updated blog, but topics I think deserve more substance will appear there.

Kuwait plans sukuk to support local banks

The Kuwaiti government may issue sukuk to support local banks including Global Investment House, which recently defaulted on its debt, and The Investment Dar, which recently requested $1 billion in loans from the government. It is unclear how the sukuk would be structured; the article said: "the government had finalised plans for a bill to issue sukuk or other Islamic financing instruments such as murabaha, using qualified firms' assets as collateral against the bonds". A murabaha financing is used for financing purchases of goods and is not typically secured by other assets. It is criticized in some cases for being nearly identical to conventional finance and would likely attract criticism on these grounds if it were used to raise capital (not finance the purchase of goods) for banks. If the financing were based on the banks' assets (e.g. buildings owned by the bank), I would imagine that the sukuk would more likely be structured as an ijara where the asset is sold to an SPV and leased back to the bank. Both conventional and Islamic banks have faced difficulties caused by credit market disruptions and falling global economic growth.

Sukuk issuance falls 66% in 2008, lowest since 2005

The issuance of new sukuk fell to $15.77 billion in 2008 compared with $46.65 in 2007 according to data collected by the Islamic Finance Information Service (IFIS), a drop of 66.2% year-over-year. The last time issuance was lower than the 2008 total was 2005 when $10.76 of sukuk were issued. The global credit crisis and difficult economic conditions were blamed for the fall which demonstrate that, although Islamic finance does not have exposure to the direct causes of the crisis (subprime-backed mortgages and derivatives), it is affected by the health of the conventional credit market and global economic conditions.

Cerulli Associates estimates that Shari'ah-compliant funds have $65 billion in assets under management and are expected to grow at an annualized 12% rate. The article describes this total as "a figure that’s more modest than the hundreds of billions of dollars often cited by regulators and industry players". Although there is fair criticism to the $300-$500 billion number often cited as the size of the Islamic finance industry (reliable statistics are largely unavailable), the $65 billion in the fund management industry should not be compared with the "hundreds of billions of dollars". Usually the $300-$500 billion figure is cited to account for the entire size of the Islamic finance industry worldwide which includes assets management, retail banking, sukuk and the other areas of Islamic finance like private equity.

The Dubai Shariah Hedge Fund Index was launched containing four Shari'ah-compliant hedge funds using Shariah Capital's long/short trading platform, most of which focus on commodities. Because conventional short selling is not Shari'ah-compliant because of prohibitions of selling things one does not own, the hedge fund platform has raised some criticism that the idea of an 'Islamic hedge fund' is not possible nor desirable.

The growth rate of the Islamic finance industry is expected to exceed the general economic growth rate in Malaysia. The second finance minister of Malaysia Nor Mohamed Yakcop believes the Anglo-Saxon capitalist system has failed and "If the Islamic banking system had made an impact earlier, then it may have been possible to avoid the economic disorder as the system will not bring such problems". I believe this is further expression of naivete that the Islamic financial system will not be accompanied by any of the problems of its conventional counterpart such as greed.

A real estate company in the UK used Islamic finance to refinance the debt on its property holdings in London.

Indonesia will issue a sovereign sukuk aimed at retail investors in February.

One of the conventional banks in Kuwait, the Global Investment House, has defaulted on its debt. Global Investment House along with Islamic bank The Investment Dar announced that they needed up to $1 billion in loans from the government. The Investment Dar has been reported to be selling assets including part of its stake in Aston Martin which it acquired in a Shari'ah-compliant LBO in 2007.

Islamic finance 'not immune' to credit crisis--Moody's; Standardization at the DIFC

Reuters came out with an article today (in response to a Moody's report [pdf]issued last week) to pierce the mistaken impression that Islamic finance is 'immune' from the credit crisis. This is something I have tried to emphasize as a note of warning (including in my 'Expert Opinion' column in Business Islamica magazine ('No room for complacency: Islamic finance faces its own risks', December 2008, pp. 24-25). Although there are a number of factors that helped Islamic finance avoid some of the most egregious products in the credit crisis, they are not immune from spillover effects in the property and equity markets, as well as general economic conditions. The Reuters article describes:

"Moody's said Islamic financial institutions in the Gulf showed strong resilience during the global financial turmoil, but that they are not risk-immune due to a shortage of liquid instruments and the lack of an Islamic interbank market. [...] Islamic banks now stand in the same firing line as their non-Islamic counterparts, facing a slump in equities valuations and a slump in Gulf real estate, to which they are heavily exposed. Even though Islamic banks avoided the speculative investments and complex financial instruments that derailed Western banks, their balance sheets still show a mismatch between assets and liabilities, and they depend more on short-term maturity liabilities than conventional banks."

Now that there is more awareness from prominent sources like Moody's and Reuters (and talk of a post-bubble Dubai), I feel a little freed up from trying to be the Cassandra and go back to writing about the aspects of Islamic finance that are the most promising.

A consultancy, Minhaj Shariah Financial Advisory (MSFA), has been named to organize a Shari'ah board for the Dubai International Financial Centre (DIFC). The Shari'ah board will provide Shari'ah rulings for companies at the DIFC and also "approach government entities and encourage the Central Bank to appoint a Shariah board to monitor the country’s banking sector". This is a positive step for the GCC region along the lines of the central Shari'ah Advisory Council in Malaysia. Unlike Malaysia, the central government will not appoint a board which decides on which products are halal and which are not and individual institutions will still be able to appoint their own Shari'ah boards, I think this is a huge step towards providing some standardization in the application of Shari'ah to financial products because it will provide comparability in 'fatwa standards' because the scholars issuing the fatawa will be the same across the companies which approach it.

Dubai-based Noor Islamic Bank is postponing its global expansion plans in the wake of the credit crisis. The Investment Dar, the Kuwaiti investment company which bought Aston Martin in a large Shari'ah-compliant leveraged buy-out in 2007, may sell 10% of the company to a Saudi investor.

As the sukuk market recovers, Turkey plans to issue its first sukuk using the ijara structure. Foreign Policy has an article about Islamic finance that provides a balanced look at proponents and critics of the industry.

Barron's has an article about the Shari'ah-compliant commodity funds being developed. Foreign policy has a balanced article about the Islamic finance industry and, in particular, the role of Shari'ah scholars.

The Islamic Financial Standards Board released a draft of new standards. The IFSB is a standards setting body based in Kuala Lumpur. It will be accepting comments over the next five months. l

Non-Muslims not sought out by GCC Islamic banks; Tier II capital sukuk issued; More data on Dubai's real estate market collapse

Most non-Muslims in the GCC do not seek out Islamic banking products at the retail level, instead opting for conventional banking products. However, some seek out Islamic banking products because, in the words of one Malaysian expat: "Malaysians have a sense of what Islamic banking is about. Maybe the returns are not that high, but it feels more secure and safe." In other cases, non-Muslims receive financing from an Islamic bank because that is what is available, for example, at a car dealership. Jawad Ali, a partner at King & Spalding, believes that retail Islamic banking products are not "geared towards retail customers" and receive more attention from high net worth clients who care not only about the cost, but are interested in how the financial product "works" to ensure it is Shari'ah-compliant. There is also very little need for Islamic banks to attract non-Muslim clients because the demand from Muslims has not yet been saturated.

Saudi Hollandi Bank issued a SAR 775 million ($207 million) sukuk as the first tranche of SAR 1.5 billion in Tier II capital. Tier II capital includes debt that is subordinated to the bank's depositors. The sukuk is callable after 5 years and returns Saudi Interbank Offer Rate (SIBOR) plus 200 basis points and is a mudaraba sukuk. This sukuk is an example of one in which additional transparency from the bank and the Shari'ah board about its Shari'ah-compliance would be helpful. It appears to be the equivalent of a floating rate bond benchmarked to an interest rate. It would be useful to see how the return on the investment is related to the underlying profits of the bank, rather than just based on a market-derived interest rate disconnected from the bank's operations.

AIM-listed Tejoori, a Shari'ah-compliant investment trust, released preliminary earnings for 2008 that showed a significant loss and very little remaining cash following a full change in their board in April 2008. The preliminary report for 2008 also mentioned that the new board would reduce its "high exposure to the Dubai real estate market".

I normally do not concentrate on individual company's results (and do not make any recommendations of any investments), but this company has investments primarily concentrated in real estate in Dubai and its difficulties, I believe, are indicative of a collapsing bubble in real estate in parts of the GCC, most noticeably in Dubai. The largest Tejoori investment is in the Lagoons, a project in Dubai managed by Omniyat Properties. Another company working on the Lagoons recently announced layoffs from staff working on other projects. The article described the real estate market in Dubai: "In just two months, Dubai has moved from being a safe haven to a market where virtually no major project is left unaffected by the credit crunch". The difficulties in the real estate market in Dubai may not have anything to do with Islamic finance, but as I have said before in this blog, Islamic finance is affected by global economic conditions and investment companies and banks in the GCC with a lot of exposure to the real estate market may see the greatest declines as the credit crisis sweeps across the globe. This is merely one example.

University Bancorp, the parent company of University Islamic Financial Corp, decided to voluntarily delist itself from the NASDAQ to save money on legal and accounting costs associated with being a publicly traded company.