AAOIFI provided a timetable for its review of the Shari'ah-compliance of Islamic financial products. They will begin the process in June and begin screening products in the second half of 2010. This is an interesting expansion of AAOIFI's traditional role of setting standards for the Islamic finance industry, but it is important that the industry remain some degree of consistency in the product's adherence to a common set of overarching Shari'ah standards. The one thing that will be vital to ensure that the industry is engaged in a positive way with the Shari'ah review is for AAOIFI to provide a transparent process to evaluate products' Shari'ah-compliant.
Reuters Islamic Finance Summit
Islamic banks in Indonesia have been and expect to produce returns on equity twice that of conventional banks. The additional return on equity is likely due, at least in part, to the rapid growth of the industry in Indonesia. One area which is somewhat concerning is that Beny Witjaksono, president of Bank Mega Syariah Indonesia, who said that the profitability was in part due to the finance fees being about twice that of conventional financial institutions. This is concerning because the Islamic finance industry needs to remain competitive with conventional financial institutions. It should not be financing growth and profitability at the expense of customers above the cost of finance offered by conventional financial institutions.
The ta'hawwut standardized Shari'ah-compliant derivatives contract's launch (being developed by ISDA and the IIFM) is "imminent" according to Simon Eedle, managing director of Islamic banking at Credit Agricole CIB. I wrote a comment on the FT Alphaville blog (who graciously linked to this blog):
The idea of a Shari'ah-compliant derivative is not necessarily a contradiction in terms. Islamic finance, just like conventional finance, has a need for hedging against unexpected changes in exchange rates, commodity prices, interest rate (which affects the industry through its use as a benchmark for pricing financial products).Alliance Takaful is in talks on a sukuk issue. In part, the move is described as encouragement for the issue of more high-grade corporate issues that takaful companies need to invest in to fill the asset side of their balance sheet to match the longer-term liabilities. The article does a very good job explaining one of the manifestations of the asset-liability maturity mismatch facing other Islamic financial institutions including takaful providers. In addition, the CEO of Allianz Takaful, Abdul Rahman Tolefat, describes the difficulty in competing with banks for new sukuk issues, particularly in sovereign sukuk. He suggests that issuers allocate a percentage (10-15% was his number) of the new issue to takaful providers to allow them to subscribe to high-grade sukuk that they may not otherwise get access to if the issue is significantly oversubscribed.
However, the tricky part about derivatives from the perspective of Shari'ah-compliance is how to create them so that they can provide the necessary hedging (a transaction that in one way can be thought of as altering the risks and returns between different parties) without providing a way for investors to speculate. For example, the difference between a conventional investor who holds a bond and buys credit default protection on that bond, versus an investor who buys a credit default swap on a bond he does not own.
There is an additional problem from the Shari'ah-compliance perspective (as I understand it, and I am not qualified to give anything more than my opinion on the subject) is that by its very nature, a derivative (whether an option, swap or other product) involves one person gaining at the other's expense, which is viewed as close to gambling and on the face of it, would not be something that Islamic finance should get into. However, creating ways for Islamic investors to hedge risks is something that is useful to the productive running of the economy (why make manufacturers who export goods also be currency market experts?). This could be the reason for the delay.
Standard Chartered is about to launch an Islamic commodity derivative for clients to be able to hedge against the price of various commodities, something they say they have been working on for 15 months. It will be interesting to see how the new product interacts (particularly in terms of acceptance from clients) if the ISDA-IIFM product is launched shortly. The long development process could be a detriment to Standard Chartered based on the price they are able to offer to clients when competing with standardized derivatives under the ISDA-IIFM master agreement. The new products will each have to incorporate the development cost in their product's cost. Standard Chartered undertook the product development cost on their own and absent a subsidy from other areas of the bank, the cost of their Shari'ah-compliant derivative will incorporate additional cost that financial institutions using the ISDA-IIFM master agreement will not necessarily have to bear. That being said, the availability of a number of different products to accomplish the same goal of hedging against external risks is a positive for the industry by forcing industry participants to determine which is the best product and this will ensure that future development is done in a competitive environment.
Sonya van de Graaff, a partner at Brown Rudnick, offered some good commentary on the Islamic finance industry at the Reuters summit which are summarized in an article. She points to the Nakheel sukuk debacle as providing investors with a reminder that the sukuk structure was complex and overlapped several legal systems. I have discussed the Nakheel sukuk in depth in other posts. The article ends with a quote from Ms. van de Graaff that I think should have been recognized by the industry far earlier than it was
"There was sometimes the impression during the crisis that hit western economies from 2007 that the stretched loans-to-value at the root of the problem could never happen in Sharia finance because of restrictions on leverage limits. Well, they did"There were two other articles from the Reuters summit, one on Bank of London and the Middle East and one on the prospect of asset sales by Gulf Finance House.
- The new product from Australian bank Westpac is described in a little more detail and there is a link to the government study of Islamic finance (pdf).
- The Central Bank of Bahrain's al-ijara sukuk issue was oversubscribed by 200%.
- ThomsonReuters launched their Islamic finance gateway.
- Indonesia cancelled a 1 trillion rupiah ($107 million) in sukuk it was offering, without specifying a reason. An analyst quoted in the article suggested that the investors demanded returns higher than the government was willing to pay.