Dar Al-Arkan sukuk

The Dar Al-Arkan sukuk was one of the first, if not the first, sub-investment-grade sukuk to be issued following the credit crisis and the sharp decline in sukuk issuance that followed. I have not had a chance to fully review the structure until now, but there are a few areas where the sukuk deserves its sub-investment-grade rating, in my opinion, apart from any credit rating of the issuer.

Dar Al-Arkan is a Saudi Arabian real estate company that invest primarily in undeveloped land, although it is expanding its property management business, which is generally a less volatile source of cash flow because it does not depend on the prospects for new developments as much. The sukuk uses two SPVs, one domiciled in the Cayman Islands which issues the sukuk and acts as trustee for the investors. The funds from the sukuk are then placed with another Saudi-domiciled SPV that manages the investments for the investors. The latter SPV is owned entirely by Dar Al-Arkan.

The first issue this creates is that it makes any investors' claims dependent upon the Saudi legal system, which does have a track record based on the numerous foreign oil companies operating within the country, but which is an emerging market and those concerns are also present within the Kingdom as well, in my estimation. The fallout from the Nakheel sukuk (before it was repaid with assistance from Abu Dhabi) focused attention on whether investors could enforce claims within a Gulf emerging market legal system as easily as they could within a developed market legal system, which generally has a more predictable legal system. There was a dual legal system structure in the Nakheel sukuk with the sukuk governed by English law and the mortgage provided to investors enforceable under Emirati law. In the Dar Al-Arkan sukuk, however, there is not the additional complication of a quasi-state-owned company as there was with Dubai World.

Once the funds are transferred into the Saudi SPV, the SPV acts as wakil under a wakala agreement to provide murabaha and ijara financing to subsidiaries of Dar Al-Arkan with returns greater than the periodic distribution amount of 10.75%. The first issue is one of a perceived conflict of interest with the owner of the wakil being the owner of the subsidiaries who will receive financing through the ijara and murabaha agreements. The sukuk is certainly an unsecured offering with a guarantee by Dar Al-Arkan only applicable as I read the offering memorandum if the investment manager is negligent. The portfolio of assets has to be managed in a way that ijara make up at least 51% to ensure the sukuk are tradable under commonly accepted Shari'ah standards (e.g. the most recent Islamic Development Bank sukuk).

My main point of concern with how the structure is created is that it relies on the investment manager (owned by Dar Al-Arkan) making arms-length transactions with other Dar Al-Arkan subsidiaries. This is possible, but with a fixed return on the sukuk and the excess amounts being retained by the investment manager, there is a strong incentive that is not necessarily in the investors' favor. If the investment manager is not negligent, any excess return above the 10.75% is retained by the investment manager (essentially by Dar Al-Arkan), while any losses based on non-payment of the murabaha or a deterioration of the value of the ijara assets are borne by the investors.

If I were an investor (I am not), I would much prefer to have the investment manager be independent of the issuer of the sukuk (Dar Al-Arkan) to ensure that incentives are aligned with the interests of investors instead of being conflicted with both sides to each ijara or murabaha agreement being owned by a common owner (Dar Al-Arkan). In reality, the sukuk is a debt of Dar Al-Arkan, but there are enough different entities involved that if the projects didn't materialize in the way anticipated by Dar Al-Arkan, it could create a significant tangle for lawyers and various courts to unravel the investors' claims.

Note: Because this post is about a specific investment, I would like to emphasize that (with all of my posts) it is not investment or legal advice, nor is it an offer or solicitation to buy or sell any security.

So Far: The Journal of Strategic Thought in Islamic Finance (volume 1)

As a contributor to "So Far: The Journal of Strategic Thought in Islamic Finance", I might be biased in my opinion of the first issue, but I thought it presented a unique forum for in depth analysis of some of the current issues in Islamic finance. The first issue discussed whether sukuk have been discredited by the recent defaults and what can be done to restore their credibility in the future. I would recommend a read of the whole issue, which is available for free from Yasaar Media's website. Just go to the 'Products' page on the website to download the full issue as well as the other reports Yasaar Media has released, including the one on Islamic finance in North America which I had the honor of writing. I have presented a couple excerpts for the contributions below, but I would still recommend reading the full issue as the excerpts do not do the contributors' essays justice.

Raja Teh Maimunah Raja Abdul Aziz

"Investors and market observers alike were too quick to conclude the failure of Nakheel to meet its debt repayment as a failure of the instrument i.e. Sukuk whereas the frustration I suspect stems mainly from the fact that they all thought that the Nakheel Sukuk was guaranteed by the sovereign i.e. failsafe. The lesson learnt here is that a guarantee, if not explicit, cannot be relied upon."

Blake Goud

"With the rhetoric of Islamic finance focused on the sharing of risk and return, the move towards Ijarah Sukuk that replicated a conventional unsecured debt bet the house on the success of these Sukuk in a global financial maelstrom. When Nakheel‟s Sukuk was on the verge of defaulting, all eyes turned towards it and Islamic finance‟s image in the global mindset became intertwined with its success or failure."

Dr. Armen V. Papazian

"This short article proposed the concept of Space Value of Money as a universal parallel to the Islamic principle that prohibits interest, and seeks to incorporate real activity into its instruments and structures. Indeed, Islamic finance requires products and investments to have a space value of money, thus requiring a positive, real, and ethical contribution to society and economy."

"If an investment project is earning its return based on more than time and capital alone, i.e., it uses real assets and real people, then it has a Space value of money as well. In other words, it adds and impacts the physical environment and its inhabitants."

David Vicary (Daud Vicary Abdullah)

"Secondly, in the area of transparency Shari‟ah rulings. The industry needs to build a process whereby the way in which a Shari‟ah decision is reached is brought to the attention of the public in a transparent way. It is insufficient, in my view, to rely on a process whereby Shari‟ah scholars, no matter how eminent, are not obliged to declare the process of their thinking and how they have reached the conclusion they have reached. Implementation of such a process would do a great deal not only to provide education but to broaden the credibility of the decisions reached to the whole world, both Muslim and non-Muslim."

Paul McNamara

"My worry is that if, as the global financial crisis begins to recede and the Sukuk market begins to gather steam, we simply act like nothing happened then we are doomed to repeat past mistakes. We must learn from our past errors of judgement in order that we build a system that is most robust and healthy than that which prevailed in the past. The time to do that is now and the time for healthy debate is now also."

Dubai World debt restructuring and Islamic finance in a restructuring

The details of the Dubai World proposed restructuring plan are still not fully known. However, what is known is that Dubai will fund Dubai World with $9.5 billion, of which $8 billion will be provided to Nakheel under the proposed restructuring proposal described by the media. Of this, $4 billion will be used to restart projects at Nakheel and repay the maturing sukuk with a combined principal amount of $1.75 billion. To restart projects, smaller trade creditors would receive full payment and larger trade creditors would receive 40% payment in cash with the remainder paid with a tradable security that could be held for full repayment or sold to another party. One of the concessions by Dubai's government is that it will place itself lower than other creditors in receiving a return of the funds it has injected in Dubai World of $8.9 billion by the Dubai Financial Support Fund (DFSF) and will convert this into equity. The remaining Dubai World debt holders' fate is less clear although it is believed they will be repaid in full over a lengthened 5-8 year period at lower interest rates than the debt pays currently.

While the plan faces an uncertain fate because it must be approved by creditors, it does raise a question in my mind about the different treatment of Nakheel sukuk holders. Why would Dubai provide full repayment of the 2010 and 2011 Nakheel sukuk and not other debts? There is an Islamic facility for $1.2 billion for Limitless, the international property arm of Dubai World, that matures in March 2010 that was reported to be rolled over with the maturity extended and possibly also excluded from Dubai World negotiations. One of my first reactions to the Nakheel sukuk being repaid was that perhaps their Shari'ah-compliant nature meant that rolling them over by extending the maturity would have raised too many Shari'ah-compliance issues and therefore was repaid on schedule to avoid these constraints. However, the Limitless Islamic facility is not included in the restructuring proposal details that have been released and its size relative to the Nakheel sukuk is comparable.

However, without any additional information provided, I cannot speculate on the cause of the different treatment, but it is an interesting area to explore how a sukuk could have its maturity extended. In general, creditors are supposed to provide additional time for debtors to repay outstanding debts but cannot condition this extension of time upon a fee. However, many of the commonly used structures appear to be flexible enough to extend maturities of outstanding debts. For example, in an ijara, the rental period can be extended and the purchase undertaking amended to extend the date on which the creditor can compel purchase by the debtor. This would have the effect of lengthening the maturity of the ijara agreement. In a mudaraba or musharaka, the partnership can be extended but there would probably be issues with a fixed 'anticipated profit' on the mudaraba or musharaka without incorporating the new rules on these sukuk that would put some of the principal at risk if the underlying business cannot generate sufficient profits to repay principal plus anticipated profits.

A murabaha would be more difficult because after the sale of the good with a markup is already accomplished and the cashflows are a debt and extending the maturity with additional profit payments would probably not be allowed. However, the debt could be repaid with a new murabaha (e.g. commodity murabaha or tawarruq) that would effect the same thing as extending the debt with continuing interest payments. An istisna'a contract could be extended using the same commodity murabaha or tawarruq transaction.

However, does this extend too far beyond what Shari'ah scholars would permit as Shari'ah-compliant because they are moving away from providing financing alternatives into an area where they create the extension of a debt maturing in exchange for a fee? This is more than I can even speculate on because I am not a Shari'ah scholar, but it should provide the starting point for discussion on how Islamic finance could work within a debt restructuring.

Sovereign sukuk issues, other news

There have been no benchmark sovereign sukuk issues this year, according to Reuters. Malaysia is considering issuing a global sukuk to provide a benchmark for local sukuk issuance. A benchmark issue is usually over $500 million. The lack of sovereign sukuk comes despite the intentions of a number of countries including the UK, Jordan, Kazakhstan, the Philippines, Indonesia that have stated that they plan to issue sovereign sukuk. Three months into the year, I am not too worried that there will be no sovereign sukuk issues for the year, especially with a smaller (~$100 million) Indonesian sukuk issuance planned for March 30. However, there are still risks. Greece and Dubai were the flash points of the fall and both could shake emerging market credit markets if there are further problems and Portugal's downggrade could also make it harder for emerging market countries to tap the international credit markets. However, the scale of the issuance by countries across the emerging markets, not to mention the developed world like the UK, dwarf the size of a benchmark sukuk issue. The more important point is that many emerging markets (where most of the sukuk pipeline is coming from) are consumed with dealing with the economic recession and do not have the time to deal with the legal and regulatory issues to make a sukuk issue possible. Reuters has a factbox about possible and planned sovereign sukuk issues.

Yasaar Media launched the first issue of "So Far? The Journal of Strategic Thinking in Islamic Finance". I was one of the think tank members contributing my views on the sukuk market and I would recommend it as a source of critical and strategic thinking into the Islamic finance. The current issue delves into the problems of the sukuk market recently. The first issue is available from Yasaar Media's website as a pdf

Malaysia strengthened its rules for Shari'ah board's review process to implement more transparency and documentation in the process. Not having read the rules, I cannot say for sure, but it appears that the rules would be at least in part in harmony with the call for greater Shari'ah transparency by Dr. Mohamed Elgari, which I linked to on Monday.

An article discusses the prospects of Islamic finance becoming involved with rainforest preservation in Indonesia.

A couple articles. discuss the prospects for a Dubai World restructuring proposal expected soon.

The managing director for Islamic finance at Global Commodity Finance says that the central banks in the Gulf region should develop an Islamic 'repo' transaction using sukuk for liquidity management purposes.

Other News

• More central banks in Africa may join the Islamic Financial Services Board (IFSB), the Malaysian-based standards-setting body.
  
• Assets in Islamic banks grew by 13.3% in 2009 compared with 7% growth in conventional banks within Pakistan. This growth rate is encouraging, but with conventional finance representing a much larger proportion of total assets, I would have expected Islamic finance to see growth rates be more significantly different, even given the general economic difficulties in the past year.
  
• An article proposes using the 'space value of money', which I do not completely understand.
  
• The short-term Sukuk al-Ijara issue from the Central Bank of Bahrain was oversubscribed by 330% (BD33 million for BD10 million in securities issued).
  
• Gulf Finance House says it is returning to a "back to basics strategy".
  
• Islamic banking continues to struggle to enter the Indian market.
  
• Despite all of the negative events including Nakheel, Bernama highlights some of the positives for Islamic capital market from 2009.
  
• Indonesia will offer sukuk on March 30 in an auction. There have been a few failed auctions recently with investors asking for too high yields for the government to accept.
  

Can Islamic banks be too big to fail? Dr. Elgari proposes Shari'ah governance standards, Nakheel sukuk options

A poll conducted by FinanceAsia magazine found that over 40% of voters in the poll said that Islamic finance had been damaged in the financial crisis. I agree with them, although it is more relevant whether Islamic finance was more or less damaged than the conventional financial industry in the countries where it is predominant. A direct comparison with the large banks in the U.S. and Europe is not very appropriate because Islamic banks had far less time to create toxic products (although those would have been more difficult under Shari'ah guidelines). The real lesson from the financial crisis was that there are insufficiently clear legal experience for bankruptcy and default compared to conventional finance. U.S. Treasury Secretary Timothy Geithner suggested today that too big to fail institutions should have a

"bankruptcy-like regime for large financial institutions that mismanage themselves into failure and can no longer survive without special government support. In that process, equity holders would be wiped out and the firm will be placed in a form of receivership so it can be broken apart, sold over time, with no exposure to the taxpayer."

While this has no specific bearing on Islamic financial institutions, it does highlight a similar problem facing Western regulators with regards to too-big-to-fail (TBTF) institutions as is facing the government of Dubai as it deals with Dubai World (whose subsidiaries were active in the Islamic capital markets). The problems with the Dubai World resolution mirrors the problem of TBTF institutions: there is no legal history to fall back on for guidance about how to deal with situations of crisis. With an Islamic bank being launched with $3 billion in capital, which could support total assets of between $30 billion and $60 billion assuming a 10-20x leverage ratio, it will be important for Islamic finance to consider whether this creates a systemic risk that even new bankruptcy laws developed for smaller Islamic financial institutions and players in the Islamic capital markets cannot deal with.

There is not anything wrong with a global Islamic bank with assets of upwards of $50 billion: this is far smaller than the TBTF institutions that Secretary Geithner is speaking about. However, with $50 billion in assets, this could account for 5% of total Islamic finance assets in one institutions and would be a significant size relative to many of the economies in the Gulf (ex-Saudi Arabia). For example, it is more than three times the GDP of Bahrain, which could house the bank. That rivals the ratio of RBS, Barclays and HSBC combined as a percent of UK GDP (337%). Creating a resolution regime for large Islamic banks should be a big focus for the Islamic banking industry and it would create a bad image for Islamic finance if it had to wait for an equally large crisis as the one that conventional finance faced in the fall of 2008.

It is hard to provide a good summary of Mohamed Elgari's call for greater Shari'ah governance in the Islamic financial industry and it the article from Arab News deserves a full real. His views cover the many areas including transparency in Shari'ah governance as well as creating greater public dialogue among Shari'ah scholars about the Shari'ah standards under which Islamic products are judged. He rightly notes that there will not be a consensus nor can (or should) there be total standardization of Shari'ah standards. That would remove the ability to adapt the interpretation by Shari'ah scholars to changing environments and lessons learned from how Islamic finance develops.

The first Nakheel sukuk since the one that matured in December will mature on May 13 and there are a number of options being considered according to Reuters reports. The sukuk is likely to be part of the Dubai World debt restructuring plan and the Nakheel sukuk, unlike its predecessor, does not have a guarantee from Dubai World. The most likely option according to Reuters is an extension of the maturity, although this would depend on whether the creditors would be forced to take a haircut and the size of that haircut.

Other News

• Dr. Abdel Fattah M Farah, the Economic Advisor to the Ajman Chamber of Commerce and Industry, proposes a model for a Shari'ah-compliant charitable investment bank that is very interesting.
  
• An Islamic advisory in the Dubai International Financial Centre, Tabarak Partners, will become the first such firm to be wound up under DIFC laws. With a peak valuation of AED1 billion ($272 million, mis-stated in the article as $27.2 million), it would be relatively small compared to Dubai World, but could provide an example for future (larger) cases.
  
• Al Hilal Bank received a license to open the first Islamic bank in Kazakhstan.
  
• Al Rajhi Bank has received approval to offer banking services in Jordan. The Oxford Business Group has an article on building Islamic finance in Jordan.
  
• Turkey's Islamic banks made profits of $470 million. This represents a 9% growth over 2008. Total assets grew 30% to $22.4 billion.
  
• Japan's Tokio Marine may expand its Islamic insurance operations.
  
• The new ETFs allowed by the Saudi Arabian regulators can include sukuk and commodities.
  

ShariaUMEX, more TID and Nakheel, wadiah-based retakaful, Islamic Repo 105?

A new Islamic exchange will be launched in London in May, the Shariah Ummah Information Exchange (UMEX). The exchange will be open to companies with at least GBP 20 million ($31 million) seeking to raise up to 20% of their market value. It will operate as a Multilateral Trading Facility (MTF) according to the chairman of Halal Industries, which will manage the exchange. MTFs are low-cost electronic trading platforms under the Markets in Financial Instruments Directive (MiFID). The ShariaUMEX expects to have 10 enterprises and 100 securities listed when it launches and hopes there will be 100 IPOs within a year. The exchange will launch Islamic equivalents to American and Global Depository Receipts (ADRs and GDRs). The primary question I have about the exchange is whether it can provide exchange listing at a similar cost to larger exchanges like the London Stock Exchange and related AIM. Presumably, the companies listed on the exchange will be subject to the same standards of reporting and transparency as other exchanges. One of the largest challenges will be whether the exchange can attract sufficient liquidity to allow relative efficiency in pricing which is necessary to attract future listings. There is certainly some minimum level of trading and listing that the exchange has to reach in order to get to a 'critical mass' where it will attract further listings.

The analysis of the TID v. Blom Bank case continues. An article in the National which continues their solid coverage of Islamic finance describes several areas where the decision could impact the Islamic finance industry as a whole. One area is the increasing Shari'ah risk in UK courts allow TID to argue that a product was not Shari'iah-compliant and therefore outside of its corporate power to enter into despite a ruling by its own Shari'ah board approving the product at the time. Generally, the ability of secular courts too enforce decisions based on religious rulings is a negative because they do not have the expertise to make a ruling in this area. The decision of a Shari'ah board that a given product is Shari'ah-compliant should be what determines whether the company can enter into it. If this is changes so that ex post, the bank can argue in a secular court that a contract is not Shari'ah-compliant for nearly any contract it has entered into if it is in financial difficulties. This erodes the role of the Shari'ah board as the arbiters of what is or is not Shari'ah-compliant. Shari'ah boards should be given the exclusive authority to judge Shari'ah-compliance of a given contract and be allowed to force an institution to change its implementation of a Shari'ah-compliant contract if it is doing os outside of the bounds of the original fatwa. The secular courts, on the other hand, should be limited to judging whether the specific aspects of the contract have been followed, not whether it is Shari'ah-compliant or not. The claim by the TID that the contract was not Shari'ah-compliant because it stipulated a fixed rate of return is another separate issue that Shari'ah scholars can discuss and highlights the problematic nature of some contracts which mimic conventional products, but that is a whole other area of discussion.

Reuters weighs in with an article on the Nakheel debt problems saying that the crisis and eventually a resolution could strenghten Islamic finance by forcing the industry to deal with issues raised by the near-deafult. It has also forced investors in the Nakheel sukuk as well as others looking on to consider the limitations that a sukuk may provide in terms of creditor protections compared with a conventional bond.

Another very interesting article in The National discusses whether accounting tricks like Lehman's Repo 105 transactions could come out and bite Gulf-based financial institutions that use similarly misleading transactions. The National reports: "The [anonymous] accountant noted the example of companies issuing sukuk, which may not transfer all of the downside risk attached to an underlying asset to the bondholder. Neither does that risk appear on the balance sheet of the issuer." This is most likely referring to an ijara, mudaraba or musharaka sukuk where the asset underlying the sukuk is transferred to the SPV issuing the sukuk certificates. I am not knowledgeable enough about accounting under IFRS to make a judgement on the accounting treatment of these sukuk, but it would not surprise me if the assets underlying these sukuk were not included on the balance sheet of the issuer (with the beneficial interest transferred to the off-balance-sheet SPV). This would make it appear that there is no asset on the balance sheet that could lose value and cause the issuer a loss. There are only the debts payable to the SPV (which would then pass them on to the certificateholders). However, if the asset loses significant value, then under most sukuk structures, the bank would be forced upon maturity to repay the principal through the purchase undertaking and take a possibly depreciated and depreciating asset back onto its balance sheet. When this event occurred, the outcome would be the bank paying the par value to redeem the sukuk and receiving an asset on its balance sheet that it would probably have to immediately write down to a fair value from the purchase price, which would cause a loss. I would be grateful if any reader more skilled in IFRS accounting could enlighten me on the subject so I could provide a more accurate assessment on the potential pitfalls of sukuk structures that are described by the accountant in the National article.

The International Shari'ah Research Academy (ISRA) has developed, although not yet released, a model for wadiah-based retakaful, which would clarify who owns what in the fund better than the mudaraba or wakala model, according to ISRA. The way it would work is that takaful providers would contribute to a fund that is managed by the retakaful provider. The funds would be invested and the retakaful provider would receive an agency fee and also be liable to pay claims from the participants. In the case that there is a profit on the investments after claims were paid, the profits would be retained by the retakaful provider and any surplus amount in the account (of contributed amounts) would be owned by the participating firms. The retakaful company is able to keep the profits from the investments, so long as the claims are paid to the takaful firms contributing capital, but the difference between contributions paid and claims paid remains owned by the participants, which should reduce the incentive for the retakaful provider to invest too aggressively, because it is forced to return to participants the difference between the contributions made and the claims paid. If it recognizes substantial losses on its portfolio and there is a surplus of contributions, it would be forced to return those funds to the participants, even if its investments lost money.

With all deference to Dr. Hussein Hamed's expertise, I have to disagree strongly with his statement at the Dubai Peace Convention that "Currency value has become interest-based and, therefore, when the crash happened, the only monetary system that was not affected was the interest-free Islamic system." The idea that the Islamic financial system, either in its theoretical form or in how it is actually practiced today is somehow insulated from economic cycles is just not true. The system is operated by people, often with noble intentions, but it is just as susceptible to crisis and recession as any other economic or financial system. The degree to which it can be decimated by poor decisions through over-leveraged financial products like credit default swaps and collateralized debt obligations may be avoided. However, the problem of, for example, overbuilding in Dubai, some of which was financed through Islamic financial products (Nakheel's sukuk, for example) cannot be avoided simply by replacing the conventional financial system with an Islamic one. Human nature being what it is will always create excesses one way or another, although the Islamic restrictions may limit some of the more harmful excesses. If anything, the Islamic financial system should be more, not less, dependent upon the economy cycle because it is supposed to be based on real tangible assets and profit and loss sharing. How many sukuk need to default and financial institutions fail or nearly fail to demonstrate that a severe economic recession can take its toll on the Islamic financial system?

Other News

• Malaysia is considering offering long-term sukuk to provide investment opportunities for takaful firms to reduce their reliance on equity and real estate investments.
  
• Hong Kong will change its laws to allow sukuk issuance. Hong Kong's financial secretary John Tsang also said "We're also enhancing market infrastructure and product development and educating market participants and investors in raising the profile of Hong Kong as an Islamic finance platform".
  
• An announcement on the fate of Amlak Finance and Tamweel is expected soon. The likely outcome will be a merger into an Islamic bank that will receive government support. The reports do not describe whether the new bank will be able to restart lending, or whether it will simply wind down the two companies in the least costly way, although there is no indication that this is the likely outcome.
  
• The United Arab Bank launched its Islamic banking unit on March 17th.
  

ISDA-IIFM Ta'Hawwut Master Agreement described by K&L Gates

K&L Gates, an international law firm based in London, released a comprehensive summary of the new ISDA-IIFM Ta'Hawwut (hedging) Master Agreement. The full description is recommended reading because it raises a number of issues with the contract's implications based on the differences with a standard ISDA derivatives Master Agreement. I will put a few quotes here, but the full article, which was released March 16, 2010, is available from K&L Gates' website.

One point of note for ISDA Master Agreements generally (from Wikipedia) is:

The ISDA Master Agreement is a bilateral framework agreement. This means it contains general terms and conditions (such as provisions relating to payment netting, tax gross-up, tax representations, basic corporate representations, basic covenants, events of default and termination) but does not, by itself, include details of any specific derivatives transactions the parties may enter into. The ISDA Master Agreement is a pre-printed form which will not be amended itself (save for writing in the names of the parties on the front and signature pages). However, it also has a manually produced Schedule in which the parties are required to select certain options and may modify sections of the Master Agreement if desired. The Master Agreement would be modified to the extent the modification is mentioned in the Schedule.

The K&L Gates article describes the general need for Shari'ah-compliant derivatives:

"Although these [Shari'ah] restrictions may make a Shari'ah-compliant derivative seem like a contradiction in terms, OTC derivative transactions are not necessarily repugnant to Islamic finance principles if carefully drafted and appropriately limited in purpose. Islamic finance, just like conventional finance, has a need for hedging against unexpected changes in exchange rates and commodity prices. Surprisingly, hedges are also needed in some transactions against changes in interest rates, despite the prohibition on interest in Islamic finance, because Shari'ah-compliant transactions often use published interest rates as a benchmark for pricing Islamic financial products.

They provide an analogy to conventional derivatives to demonstrate that some can be viewed as speculation while others are legitimate needs for hedging. The ISDA-IIFM Master Agreement specifies that the derivatives transactions must be used for legitimate hedging activities only:

"One analogy is of an Islamic participant being (a) a conventional investor who holds a bond and buys credit default protection on that bond versus (b) an investor who buys a credit default swap on a bond he does not own. The latter position is not Shari'ah-compliant as it is pure speculation not based on any ownership of an underlying asset."

The removal of interest in the contracts may change the incentives in cases where counterparties default:

"The absence of interest may also affect the behavior of parties in a default situation. A defaulting party may potentially raise legal objections and elongate the process knowing that default interest is no disincentive. Equally, a non-defaulting party may prefer to continue with a transaction under a mechanism that has a premium attached rather than be left with a liquidated amount which carries no interest."

K&L Gates describes the basis for the transaction which includes two wa'ad (promises), one is a promise to enter into a murabaha transaction on certain terms and the other is a promise to enter into a musawama, which is like a murabaha except that the cost to the seller does not have to be disclosed to the purchaser:

"The absence of interest may also affect the behavior of parties in a default situation. A defaulting party may potentially raise legal objections and elongate the process knowing that default interest is no disincentive. Equally, a non-defaulting party may prefer to continue with a transaction under a mechanism that has a premium attached rather than be left with a liquidated amount which carries no interest."

Finally, the Ta'Hawwut Master Agreement covers Shari'ah compliance. K&L Gates describes:

"Therefore a party is only obliged to confirm that the transaction is Shari'ah-compliant as far as it wishes or is required to do so. This may lead to further discussions between the parties as to each other's stance on such issues. If a non-Islamic party is concerned, then it could attempt to exclude this representation. Due to the varied interpretations of Shari'ah law, users may also want to involve their Shari'ah advisers in approving the Ta'Hawwut Agreement."

This reliance on the two parties to determine Shari'ah-compliance is both a strength and a weakness in my opinion. It allows for different Shari'ah standards to be incorporated for the underlying transactions and also for these standards to change over time (at least as far as they don't affect the Master Agreement. However, they also present a risk not unlike the Shari'ah risk that characterizes other products. In general, the transactions are governed by a secular law (in the Ta'Hawwut it allows the choice of New York or English law). A party should not have grounds to object to the transaction after the fact based on its Shari'ah-non-compliance. However, the TID v. Blom Bank case involving a wakala agreement adds another risk factor: that an Islamic bank will claim that it is, under its corporate charter or under another national law, unable to enter into contracts that are not Shari'ah-compliant. In the TID case, the courts cast doubt on the claim, but did not dismiss it altogether. This case should provide a good indication about whether institutions which are specifically prohibited from entering into non-compliant transactions can use this as a defense under the idea of ultra vives that could allow them to void a contract after it is signed even if the company's Shari'ah board approved the contract at the outset. It will be an important decision, and the judge who wrote the decision indicated that the ultra vives defense is unlikely to be allowed in the end when it required TID to pay the principal amount from the wakala to Blom Bank in order to be able to file an appeal.

The K&L Gates article covers many more issues than I could quote in this short blog post and I would recommend reading it in full.

Islamic finance conferences in Malaysia and South Korea

There are a number of articles about the "Contribution of Islamic Fiannce Post Global Financial Crisis" conference held in Kuala Lumpur, Malaysia yesterday:

• "5 ways to widen Islamic finance's acceptability," Business Times
  
• "Changes to Capital Market Services Act to be enforced next month," The Star Business
  
• "Raja Nazrin: Islamic finance crucial to reform global finance rules," The Edge Malaysia
  
• "Changes in Act to strengthen Shariah Advisory Council," Bernama
  
• "Bank Muamalat: Islamic finance on steady growth path," The Star Business
  

Qatar Islamic Bank signed a memorandum of understanding with Woor Investment & Securities Inc, a South Korean investment firm, to cooperate on Shari'ah-compliant investments. A conference was held in Seoul on Islamic finance and sukuk and if legislation is passed soon, the first South Korean corporate sukuk could be issued in late 2010.

Other News

• Dubai has only tapped $500 million of its $2.5 billion loan from Abu Dhabi government-owned bank Al Hilal bank.
  
• SEI breaks down the performance differences in 2009 between the MSCI World and MSCI World Islamic.
  
• Islamic financial institutions now have $822 billion in assets according to the Saudi Arabian central bank governor Muhammad Al Jasser.
  
• Kazakhstan is planning to issue Islamic bonds this year.
  
• An Expert Council on Islamic Economy was formed in Tatarstan in a meeting organized by islamic-finance.ru.
  
• The governor of the Central Bank of Syria spoke at the 5th Islamic Banks and Financial Institutions conference held in Damascus about many of the issues (risk management, liquidity management and prospects for financing infrastructure projects) that have been at the forefront recently.
  

Dubai World, Islamic hedge funds

Dubai World negotiations continue to be released in bits and pieces to the media, and they may or may not be totally accurate. However, the latest release is that Dubai World will be split into 'good' and 'bad' companies and dealt with in separate ways. Nakheel and Limitless the domestic and international property companies within Dubai World, respectively, will be put into the 'bad' company as their prospects are more bleak with a collapse in real estate markets globally in the past two years. The 'good' company would include DP World, Ports Customs and Free Zones and Dry Docks. Statements in the past have separated these two groups of companies and it appears that that will be formalized in the proposal.

This could help move the restructuring on for the 'good' companies if they are separated and their debts are repaid in time while the 'bad' companies are worked out. However, I would imagine that the many large banks have exposure to both 'good' and 'bad' companies. This could provide more flexibility in the negotiations if they can know ahead of time that the debts of the 'good' companies will not have any haircuts requested. However, it does not address whether there will be a government guarantee on some, but not all, companies. Some proposals being floated in the media involve a delayed repayment (in some cases for the 'bad' companies with a haircut of 20%) with repayment guaranteed by the government of Dubai. This will increase some certainty, but there are still questions about whether Dubai would be able to make good on this guarantee without additional support from Abu Dhabi. The restructuring is proceeding, but is likely to continue for months if not years.

Islamic hedge funds have been slow to develop because there is not agreement on the contract, arbun, used by Shariah Capital to synthesize a short sale. Muddassir Siddiqui, a Shari'ah scholar criticized the use of arbun telling Reuters that "The payment of arbun does not transfer title to the buyer. The principle of the sharia is that you are not allowed to sell something that you don't own". There will be an uncertain for the future of Islamic hedge funds if such important aspects are disagreed on among scholars. However, it is likely that if there is broader approval of the arbun short selling contract, then the first mover advantage could be substantial.

Other News

• Sukuk issuance grew from $14.13 billion in 2008 to $20.15 billion in 2009, with half of the 2009 issuance coming from Malaysia according to the Malaysian ambassador to the UAE.
  
• Kuwait's special circuit court has granted The Investment Dar's request for protection under the financial stability law.
  
• Quarterly changes to the Dow Jones Islamic Market Indexes were released.
  
• The Jordanian government is considering ways to make sukuk issuance possible in the country.
  

The role of the top scholars in Islamic finance

A Reuters article raises a number of important points about Shari'ah review of contracts. The defaults in the industry have exposed what would otherwise be esoteric points in contract law. How much time are Shari'ah scholars able to devote to the review of each contract for which they provide a fatwa? King & Spalding's Jawad Ali is quoted: "Mistakes do happen when a sharia board focuses on the instrument being presented ... and there is little scrutiny on how the structures are being implemented," The article goes into further discussion that the reasons for the oversight are not in general due to Shari'ah scholars (at least the top scholars) not being able to consider the overall implementation of Islamic finance and how the form versus substance plays out. The Reuters article notes that among the top scholars there is too much required of them. They cannot read every page with the workload caused by the current situation.

I have long argued that Shari'ah scholars are simply overworked and the requirement that every relatively standardized murabaha contract be reviewed by a top scholar has led to too little attention being paid to controversial or innovative (depending on the perspective) product. With the ISDA-IIFM standardized derivatives contract joining the standardized commodity murabaha contract that IIFM developed (the Master Agreement for Treasury Placements), it has been demonstrated that standardization of basic contracts can occur. Not every contract or application can be standardized in such a way. However, the standardization of plain vanilla contracts can release the top Shari'ah scholars and allow them to focus on more innovative or controversial products and in the context of the Reuters article, read every page of the contracts.

The important point is that the top scholars' time is too valuable to be used reviewing the basics. Their seal of approval is important for marketing products, but there should be a recognition that a standardized contract with the implementation by junior scholars is as good or better than relying on the top scholars for every contract. Their insight is much more valuable developing new products and deciding what products are most favored and what direction the innovation should take in the industry.

Dubai World; Islamic 'lender of last resort'

News about possible options for Dubai World continue to surface in media reports and the latest is that Dubai World may seek to simply rollover its debts and lower the interest payments and repay over an eight to ten year period. The outcome for sukuk holders was not discussed specifically in the reports and I am still not sure whether the Dubai World restructuring will include specific accommodations to account for Shari'ah-compliance concerns. In my opinion, and I am not a scholar so I can't speak definitively about this, that any extension of maturity with continued lease or profit payments could be difficult because it would effectively exchange a delay in repayment for a higher level or repayment, which would probably raise some issues. However, I recall that the Nakheel sukuk incorporated defaults by extending the lease term and continuing the lease payments until repayment (analogous to what is being proposed), while retaining the lease as the source of the payments. This would probably be viewed more favorably because it would not include a delay in repayment in exchange for increasing the principal (by making periodic payments for a longer period). However, not all of the Dubai World Islamic debt is structured as ijara. One source in the FT article said that creditors could receive a share of future profits, which could be a way to extend the maturity by turning a murabaha or other facility into a mudaraba or musharaka. However, the lack of clarity on this issue in the media report suggests that there is either a minority of debt that is Shari'ah-compliant or the issue of Shari'ah-compliance is not at the forefront and is being viewed as a later issue when the general terms are agreed for something to be engineered to work around any issues. The National newspaper also offers its slightly different analysis. The Nakheel sukuk are discussed in another article as JP Morgan indicated in a note that sukuk holders could receive repayment at par.

The Union of Arab Banks says it is finalizing a way to allow Islamic banks to approach the central banks of the region for support. This is an important issue because without 'lender-of-last-resort' protection, Islamic banks are more vulnerable to runs. The lack of this support potentially can turn a liquidity crisis at Islamic banks into a solvency crisis if they are forced to unload assets at fire sale prices to meet depositors' withdrawals. This vulnerability should overshadow the more conservative lending standards in the pronouncements of Islamic banks' supposed immunity to crisis. The interbank market is important for banks to be able to have lower reliance on high levels of liquid assets that can reduce their profitability and thus the competitiveness with conventional banks. Following the launch of larger banks like Istikhlaf, which appears only to be an investment bank at the time being, there will need to be more attention paid to the systemic risk posed by larger Islamic banks. Without liquidity facilities at the central banks, investment banks and retail banks in the Islamic financial industry are extremely vulnerably. Beyond the fleeing of depositors in a 'classic' bank run, the demise of Lehman Brothers and Bear Stearns show how a run can start even without depositors if the wholesale funding partners of a bank withhold credit all at once. Both 'classic' and 'Lehman' runs should be considered in judging the urgency of establishing a 'lender of last resort' facility. When there is a new bank with $3 billion in capital expected, this could translate into $60 billion in assets (assuming a leverage ratio of 20:1). That would be a huge institution that would pose systemic risk to the Islamic financial system. It is an issue that deserves a lot of attention.

Other News

• The Dubai Financial Services Authority issued five Islamic finance handbooks for firms operating in the DIFC.
  
• Having announced last year investments in Chicago and a joint-venture with a publicly traded REIT, Kuwait Finance House is planning further expansion in the US, China and Canada. Other Islamic banks have urged China to consider Islamic banking as a way to attract capital from the Middle East.
  
• Indonesia raised 999 billion rupiah ($108.9 million) in its latest sukuk auction with a maturity range of 5 to 15 years sukuk. It had no winning bids for an 11-year sukuk auction. There have been several recent failed auctions for sukuk with investors demanding too high a yield to be accepted by the Ministry of Finance.
  
• Forbes has an article (written by Oxford Analytica) on the moves towards standardization in Islamic finance.
  
• The Islamic Development Bank will soon launch a roadshow to raise money for Istikhlaf, the 'Islamic Goldman Sachs' expected to begin operations later this year.
  
• Dar Al-Arkan redeemed a $600 million sukuk.
  
• The Jordanian government borrowed $100 million from Jordan Islamic Bank to finance a stockpile of wheat and barley.
  
• Centennial College in Toronto will offer an Islamic finance course starting in May.
  
• Has Islamic finance helped cushion Bahrain from the blow of the global recession? The finance minister thinks so.
  
• The Investment Dar continues to struggle on its restructuring and may seek protection under the country's financial stability law.
  
• Amana Takaful, a Sri Lankan takaful provider received an insurance license in the Maldives. The takaful industry continues to struggle over the lack of sufficient supply of appropriate investments, like sukuk, and a shortage of talent.
  

TID wakala case

The Investment Dar's claim that a wakala agreement it entered into with Blom Bank was not Shari'ah-compliant and therefore could be voided because it was ultra vives, or outside of the activities permitted by the corporate charter has attracted attention recently. There is a very interesting court order that describes the judge's reasoning on allowing for the appeal by TID to proceed, but with great skepticism that it will come out in TID's favor.

The basics of the transaction was the Blom Bank would place funds with TID where Blom Bank was acting as muwakkil (depositor) and TID was wakil. The judge describes:

"Thus the form of the contract was that of an investment by TID as agent. However, the investment was to be, as clause 2 stated expressly, 'in the wakeel's treasury pool'. The treasury pool was defined in another recital as meaning the wakeel's treasury pool of funds, which is somewhat circular as a definition goes."

The contract specified an anticipated profit rate that was used to determine the breakdown of profit allocation between the wakil and muwakkil. For example, if the anticipated profit rate was 5% then any profits above 5% would be retained by the wakil as an incentive fee and if the profits came out to be less than 5%, the muwakkil would retain the entire profit and give up the difference between the actual and anticipated profit rate. However, the wakala agreement added in a clause that changed the relationship in the wakala agreement:

"Clause 7. 1 provided that the funds provided by the muwakkil/depositor would be invested in the treasury pool of the wakeel with effect from the value date. It was also provided that the funds would be treated at par with the funds of the other depositors in the treasury pool, which I understood to mean pari passu. Clause 7.2 provided that on the settlement date the wakeel would pay to the muwakkil/depositor an amount equivalent to the profit stated in the respective offer. That amount was to be paid "on account of the profit" in accordance with the offer for such wakala transaction. That on account payment was to equate to the anticipated profit. Thus there was an unconditional obligation to pay the on account profit in the amount of the anticipated profit whether or not it had in fact been earned by the investment (so called) in the treasury pool. "

This essentially required that TID as wakil would pay the anticipated profit rate whether or not the profit was earned by the assets in the treasury pool. There is doubt about whether this is in harmony with the general idea of wakala, but it was signed off on by TID's Shari'ah scholars, presumably based on other details in the contract which rendered the contract Shari'ah-compliant. This led the judge in the case to argue that Blom Bank should receive an interim payment of the principal amount it invested in the wakala with the remainder (the anticipated profit) being determined later. The judge also allows TID to continue appeal on the interim payment, although expressing that it is unlikely to reverse this payment:

"Ultimately, if the master wakala contract is intra vires, the contract claim will succeed. If not, the restitutionary claim will succeed. Either way, TID is liable for at least the whole of the amounts deposited. [...] On the face of it, it should be made to Blom, but Blom, though a highly respected Lebanese company, owes no allegiance to the English court and TID is concerned that it may in the event, if all its defences ultimately succeed, have no means of recovery from a Lebanese company. Had I thought that there was at the end of the day any significant chance of that result being achieved, I would have required either a payment into court or the retention of the sums within the jurisdiction. However, as far as I can see, one way or another Blom is bound to succeed and I shall therefore order the interim payment to be paid to Blom unconditionally in the amount of the judgment sum."

The end result here is an interesting outcome whereby Islamic financial institutions operating in Shari'ah-compliant financing are left to their own for issues of Shari'ah-compliance and the use of English law requires that this Shari'ah review occur before the contract is signed. When the contracts are governed by English law, the debate about whether a contract is or is not Shari'ah-compliant will not hold much sway. This is similar to the Shamil Bank of Bahrain v. Beximo Pharmaceuticals, which limited the ability to have contracts subject to both English and Shari'ah law (with English law taking precedence). If the case proceeds the way the judge anticipates, this could secure firms engaging in Islamic finance under English law at least with regards to the principal amounts invested in wakala agreements. We will have to wait and see what the outcome is with regard to the 'anticipated profits' from wakala agreements, which will probably also apply to some mudaraba and musharaka agreements as well.

Note: I am not a lawyer. The post should be taken accordingly.

Islamic finance restructuring news

The restructuring theme is in full force right now for Islamic finance and related companies. Global Investment House received an award for most innovative deal for its restructuring that included an Islamic tranche. Dubai World is expected to approach its creditors in London which will include Nakheel sukuk creditors and those who provided financing for Limitless, which has a syndicated Islamic facility coming due. The Investment Dar may use a recently passed 'financial stability law' to protect itself from creditors who have not agreed to its restructuring plan.

Other News

• Gulf Finance House is planning to launch an Islamic bank in Syria called the Syria Finance House.
  
• An article in a Turkish newspaper discusses Bank Asya, one of the participation banks in the country.
  
• An article on Mideast fund managers provides some statistics on the distribution of Islamic funds across the world in advance of an Amanie-Failaka conference.
  
• The CEO of the Badr-Forte bank, an Islamic financial institution in Russia, is starting a new Islamic financial institution, Al-Shams Capital.
  
• I found this article with an interview with Professor Catherine Cowley about the relationship between ethics and finance interesting.
  
• Islamic hedge funds have, not surprisingly because of limited offerings, not been a prominent fixture in fund managers' portfolios with only 19.7% of Middle East investors reporting that they invested in Islamic hedge funds.
  

More commentary on TID's wakala

The Investment Dar's defense in a lawsuit filed by Blom Bank over a wakala agreement is receiving significant attention throughout the industry. The contract, in which TID acted as the investment agent for Blom Bank and was responsible for returning principal plus an agreed profit margin if the investments were profitable, was signed off by its Shari'ah board three years ago. In court case, TID argued that the contract was not Shari'ah-compliant and therefore is void. The court sided with TID and ordered that TID repay only the principal. This has attracted attention to the impact the ruling could have on Islamic finance as a whole by increasing Shari'ah risk. One unnamed lawwyer suggested that TID "is clearly in financial difficulties and clutching at straws to get out of paying but [this] may cause concern for conventional institutions considering entering into a sharia transaction."

Other News

• Reuters sums up a recent Islamic finance conference in Jordan.
  
• Belgium is marketing itself to Brunei (in addition to countries in the GCC) as a destination for Islamic venture capital funds.
  
• A Malaysian company Binariang GSM has partially redeemed $1.1 billion of its senior sukuk.
  
• The recent debt exchange by Gulf Finance House led Standard & Poor's to raise the rating from selective default to CCC- with outlook negative.
  
• Bullion Management Group, a Canadian company offering two bullion funds, received Shari'ah approval from the Islamic Finance Advisory Board.
  
• France is still expected to make changes to its legal and regulatory framework to accommodate Islamic finance.
  
• The establishment of an Islamic finance company in Kerala, India is still uncertain because of the involvement of the government and the limits of government involvement with a religiously-based financial institution. It may be changed to be an 'interest-free', rather than Islamic institution.
  
• New tax changes that would implement a goods and services tax in Malaysia will be done so that it has an equal impact on conventional and Islamic financial services.
  
• Business Week provides a list of the upcoming sukuk issues.
  

Can a debtor avoid obligations by claiming a contract is not Shari'ah-compliant

King & Spalding has a very interesting short article (pdf) about a case in English courts where a creditor of the Investment Dar sued TID to try and recover principal plus expected profit from a wakala agreement they entered into. TID responded that:

(i) TID was prohibited by its constitutional documents from entering into agreements which did not comply with shari’ah, (ii) the Agreement did not comply with shari’ah and (iii) the Agreement had been entered into beyond the corporate powers of TID and was therefore void.

King & Spalding suggest that this raises the prospect for Shari'ah risk across the industry.

The risk lies in Islamic financial institutions trying to avoid repayment on contracts they entered into by arguing that the contracts could not have been validly entered into because they were not Shari'ah-compliant and therefore the company could not have legally entered into them (because the corporate requirements were that all transactions must be Shari'ah-compliant). However, in this case, TID entered into the contract and later argued that it had not been Shari'ah-compliant. In my (non-lawyer) eyes, this essentially provides non-Shari'ah-compliance as nearly a blanket way to get out of contracts in the future if the IFI is in financial distress. The cause for the rationale by TID in this case may have been to avoid a disruption to its restructuring agreement if creditors could exit the restructuring and seek redress through English courts which govern most Islamic finance contracts.

I think the King & Spalding suggestions that close the article could provide a way to prevent this from occurring with regularity in the future and mitigate the Shari'ah risk from IFIs claiming after the fact that some contracts they entered into were not Shari'ah-compliant and were therefore void.

(i) That the IFI delivers a certificate of its shari’ah committee, or internal shari’ah advisor, confirming that the transaction is shari’ah compliant.
(ii) The deletion of any prohibition in the constitutional documents of the IFI which prohibits that IFI from entering into agreements which do not comply with shari’ah.
(iii) A representation to be inserted into the shari’ah compliant agreement stating that entry into and performance by the IFI of that agreement does not conflict with any of its constitutional documents.
(iv) The waiver by the IFI of any defenses that it might have in connection with the agreement not
being compliant with shari’ah principles.

I would suggest reading the full article because it contains more insights that I may have overlooked.

Tahawwut derivative contract, Islamic finance and Nakheel, BBA, Publications on Sukuk

The Tahawwut master agreement that establishes a Shari'ah-compliant derivative framework was released today. An article in Risk magazine does the best job of describing the process in detail. One of the sticking points that delayed the release was the inclusion of the murabaha contract in the agreement as well as the procedures for close-out netting of derivatives exposure. This allows parties to close out derivatives positions with offsetting contracts between counterparties. The result is that the close-out netting is allowed in jurisdictions where national law allows it, which excludes many Muslim-majority countries that do not have laws governing this. There was also probably a discussion among Shari'ah scholars about the permissibility of offsetting debts (like murabaha). In general, there are restrictions on this because it is viewed as trading in debt (bai' al-dayn), which is restricted outside of Malaysia. However, it is generally allowed where the debts are equal (i.e. exchanged at par). The standard was backed by other banks including Standard Chartered, which recently announced its own Shari'ah-compliant derivatives products. In an earlier post, I wondered whether Standard Chartered's product would be able to be competitive with an ISDA-IIFM tahawwut product based on a master agreement that could spread costs across many financial institutions.

Westlaw Business has a few quotes from a roundtable discussion they held of Islamic finance recently that mostly focus on the Dubai World/Nakheel situation. It highlights that the investor base was sophisticated and should have (and probably did) know that the sukuk were not legally backed by the government. One omission I see in the discussion (and the quotes are just selective, so it may have been raised in the discussion) is the inclusion of fully perfected mortgages over the properties backing the sukuk. While the structure was a transfer of beneficial interests in a long-term lease to the SPV, there were also mortgages granted to the SPV over the underlying properties. This should have provided investors with recourse to the land if the sukuk was not redeemed using funds provided by the government of Abu Dhabi and two government-owned banks in Abu Dhabi. There are all kinds of potential problems investors would have faced to turn those mortgages into actual ownership in the underlying lands (in part because the land was in Dubai and the sukuk used a trust structure based on English law and the concept of a trust is not recognized in the local jurisdiction). In discussing sukuk generally, this point is not necessarily relevant because most ijara sukuk do not contain mortgages on the underlying asset and the investors are generally provided with just an unsubordinated, unsecured claim against the issuer if the issuer can not or does not repurchase the asset in case of a default. An article summarizing a discussion at the recent Reuters Summit on Islamic finance looks at the Dubai World/Nakheel situation in a different light, with participants suggesting that the problems with the Nakheel sukuk highlight the need for greater product diversification in Islamic finance to allow portfolio managers to have greater opportunity for diversification.

Affin Islamic Bank, a Malaysian Islamic subsidiary of Affin Bank, says it will continue to use the bai bithamin ajil (BBA) contract, despite criticism. RHB Islamic said earlier it stopped using the BBA contract to adopt global Shari'ah standards reflecting the more stringent requirements, particularly in the Gulf. The primary difference between a BBA and murabaha contract is that in a BBA, the client makes a deposit to the seller and then transfers the rights to acquire the property to the bank which then sells it back to the client on a cost-plus basis in installments. In a murabaha, the bank buys the property and then sells it to the client on a cost-plus basis with repayment in installments. The criticism of BBA is its reliance on bai' al-inah (sale and buy-back). In contrast to the murabaha contract the transaction is executed between only two parties and therefore is viewed as a hidden (conventional) loan. The murabaha, in contrast, separates the purchase (from the third-party seller) from the sale (to the client) and is more widely viewed as legitimate.

Islamic Finance Resources has four links to recent reports on sukuk. The links are to the Zawya Collaborative Sukuk Report, the Guide to Issuing Sukuk in the DIFC, a guide to issuing sukuk from Bank Negara Malaysia and the Malaysian Securities Commission, and the description of several types of sukuk from the Malaysia International Islamic Financial Centre.


Other News

• Deutsche Bank received an international Islamic banking license from the Malaysian central bank, Bank Negara, that allows it to provide services in foreign currencies.
  
• The Central Bank of Bahrain's Sukuk al-Salam sukuk was oversubscribed with a bid-to-cover of more than 4 times with BD56.8 million in subscriptions for the BD12 million issue.
  
• An experiment in Islamic microfinance in Pakistan described in brief.
  
• Israeli fund managers are offering investment products that comply with the prohibition of interest (ribbit) as well as other prohibitions, which shows how the prohibition of riba in Islam is mirrored in other Abrahamic faiths.