Email problems

This weekend, while moving the hosting of the sharingrisk.org website (which was also updated), there was a disruption in email from midday Saturday (Pacific time) until late Sunday evening. If you emailed me at blake@sharingrisk.org and the email bounced, please resend as the email problems have now been fixed.

Sorry for the inconvenience.

Malaysia sovereign sukuk issued for $1.25 billion, Dubai, Islamic repo

Malaysia sovereign sukuk
The big news of the day was Malaysia's latest foray into the sukuk markets, the first by the sovereign since 2002 when it issued $600 million in sukuk. The latest issue was expected to be $1 billion, but with an order book reported to be between $4 billion and $5.5 billion, the issue was increased to $1.25 billion. The pricing, expected to be 180-190 basis points over US Treasuries of similar maturity, came in at 180bps on the low end of the range. This is the largest sukuk issuance since Dubai's $1.25 billion issuance in October 2009 before the Emirate saw its government-related entities like Dubai World run into trouble servicing its debt. Along the trend of the post-AAOIFI ruling market, this was an ijara sukuk which has become the most common form of sukuk issued since the rules on mudaraba and musharaka were strengthened to be more restrictive. In the first day of trading, the yield narrowed as investors bid up the sukuk. The sukuk was issued at 3.93% and finished its first trading day yielding 3.87%, 171bps higher than US Treasuries, a narrowing of the issue spread by 9bps. The state-owned oil company Petronas has seen its 4.25% sukuk issued last year trading with a 2.07% yield, which is in line with the historical spread between the sovereign and state-owned company's yields.

Prior to the issue, I was concerned that there would be too little trading to provide guidance as the economic and interest rate environment in Europe and globally evolved, but it appears that there is already secondary market activity, which should allow this sukuk to serve as a useful benchmark for corporate sukuk issuance (at least within comparable maturity range, denominated in US Dollars and issued by Malaysian issuers). As I mentioned, the issuance of another 5-year sukuk does little if anything to provide a lead for issuers looking to issue longer-dated sukuk, which are an important need for takaful providers and other investors looking for long maturity assets. However, with the difficult financing market globally because of worries about the fate of the Eurozone as well as continuing concerns over sukuk defaults, it is good sign that Malaysia's sukuk offering received such strong interest. We will have to wait another day for a sovereign sukuk with a 10-, 15-, 20- or 30-year tenor.

Dubai
In another hit to Dubai's reputation, cooling company Tabreed missed a periodic payment on its AED1.7 billion ($462.8 million) sukuk. The company is currently working on a recapitalization plan. The restructuring plan includes not just this sukuk, but debts totaling $1 billion. The two largest holders of the sukuk who collectively own more than 50% of the sukuk were consulted before the missed payment and one, Mubadala, provided an AED 1.3 billion facility to Tabreed as part of the recapitalization. The company expects to make a payment due in July on its $200 million floating rate sukuk.

Dubai International Capital, a private equity unit in Dubai Holding, is requesting a three-month delay on repayment of some of its debts. In an article, Noor Islamic Bank CEO Hussain Al Qemzi says the bank continues to expect to achieve profitability by 2012. He also said that Dubai Holdings is not another Dubai World and that Noor Islamic Bank has a small exposure to Dubai Holding, which owns Dubai International Capital.

In a case of "less bad" news, builder Arabtec says Nakheel is not in arrears to the company "as much as some analysts fear". That is hardly a ringing endorsement for efforts by Dubai to bring Nakheel current with many of its trade creditors.

Islamic repo and liquidity management
In what potentially could be a significant development, the UAE central bank is planning to offer daily auctions of commodity murabaha with one week to one year maturity to help Islamic banks manage liquidity. The Islamic certificates of deposit would fill an important gap in the Islamic finance industry where short-term liquidity management tools are rarely offered by central banks. The daily auctions would provide an important datapoint for investors and Islamic bankers. The central bank also anticipates using these CDs to manage liquidity through repurchase (repo) agreements, along the lines of the short-term ijara sukuk issued by the Central Bank of Bahrain. The difference between an ijara sukuk and a commodity murabaha is that one represents ownership of an asset while the other creates a debt stream that may raise Shari'ah issues over its use in a repurchase agreement. However, these issues have probably already been reviewed by Shari'ah scholars. The need for liquidity management tools for Islamic banks and central bankers, however, may be so important that their presence, even where this is viewed with some skepticism, may outweigh the cost associated with a controversial application.

Other News

• Moody's showed up a little late with a report that the Investment Dar case against Blom Bank where TID was allowed to proceed to trial claiming that a wakala agreement should be voided on the basis of non-Shari'ah-compliance presented an "operational risk" to Islamic finance.
  
• Malaysia's central bank and Securities Commission are working on a plan to make Malaysia a center for non-ringgit-denominated sukuk, as well as other areas within Islamic finance. Previously, there has been a lot of development in sukuk markets denominated in ringgit with fewer non-ringgit issues. This is in contrast to the GCC where issuers have brought both local currency and US Dollar sukuk to market.
  
• Saudi Electric Company, which has issued several domestic sukuk, plans to tap the international sukuk markets in 2011.
  
• The Australian government is reviewing its tax laws to put Islamic finance on equal footing with conventional finance and the assistant treasurer Nick Sherry points out that Islamic finance can have a broader appeal besides just Muslims as a form of socially-responsible investment (SRI). If it wants to attract the SRI consumer base, however, I believe Islamic finance will have to move beyond just 'negative' screens and incorporate 'positive' screens for companies that contribute to the social good.
  
• The latest summary of the Dow Jones Islamic Indexes is available through the end of May.
  
• Jordan Dubai Islamic Bank began trading on the Amman stock exchange.
  
• Malta continues to examine how regulations need to be adapted to incorporate Islamic finance.
  
• S&P put Kuwait Finance House's long-term counterparty credit rating on Credit Watch Negative.
  
• The first Islamic bank in Tunisia, Azzitouna Bank, was launched on Friday.
  
• The Gulf Bond and Sukuk Association signed a memorandum of understanding with the Trade Association for the Emerging Markets (EMTA).
  
• There is a summary of tax legislation on Islamic finance in South Africa.
  

Tuesday news bullets

• Rushdi Siddiqui opines on the possibility for a World Cup or Olympics sukuk in the future as a few countries in the GCC are considering bids to host the competitions.
  
• DBS Group is shrinking its Singapore-based Islamic unit which Reuters attributes to a struggling effort by Singapore to attract Islamic finance.
  
• A report from Ernst & Young about Islamic funds found that the segment of the industry stagnated. There were four articles with slightly different takes on the report including the press release from E&Y. The other articles were from Emirates Business 24/7, Reuters and Gulf Times.
  
• There are fresh concerns that Islamic finance has too few well-known Shari'ah scholars.
  
• The Global Head of Islamic Markets at Bursa Malaysia recently said at a conference that Islamic finance needs to develop a more diverse set of investment products to cater to investors with different investment needs.
  
• Kenya's central bank may allow Islamic financial products in the country two years after the first Islamic bank in the country was licensed.
  
• The Cagamas sukuk being developed with Al Rajhi Bank will be for $3.02 billion and will be structured to be acceptable in the Middle East as well as in Malaysia.
  
• Indonesia's latest auction of sukuk had no winning bidders as the finance ministry rejected the 1.2 trillion rupiah ($130 million) in bids.
  
• Bahrain's Islamic finance industry is recovering in spite of the worries around the Greek debt crisis, although it could affect sukuk issuance through the first three quarters of 2010, according to Nida Raza of Unicorn Invesment Bank. Another article describes the Islamic banking market in the UAE including their use of e-banking.
  
• It appears that the structured product market in Islamic finance is returning with another, offered by Dubai Islamic Bank, that returns 88% of capital after two months but pays profits on the full amount invested based on the performance of the Middle Eastern markets.
  
• The Association of Islamic Banking Institutions Malaysia believes that the country has exceeded the 20% target for the market share of Islamic finance this year. The new banking licenses for foreign banks are expected to be announced although the two new Islamic banking licenses may be delayed.
  
• The GCC represents 70.4% of the global takaful market.
  
• An article in Arab News expresses hope that the growth in the number of conferences on Islamic finance in the Commonwealth of Independent States (CIS) reveals a potential growth area for the industry.
  
• Islamic finance in the UK will not be negatively affected by the change in government according to a delegation from the Muslim Council of Britain to the World Islamic Economic Forum in Malaysia. The Bank of London & the Middle East is planning an absolute return fund that "it is in no way a hedge fund". The BLME launched a money market fund last year that has returned 0.30% compared to an expectation of 1.00% which it expects to reeturn once yields 'normalize'.
  
• The Malaysian retail 1Malaysia sukuk has received a 'lukewarm' response.
  

Dubai World, Nakheel update

The Dubai World agreement in principle is described in a Gulf News article that describes in broad terms the level of write-downs banks holding Dubai World debt will have to take. The article, however, does not address whether I was correct in calculating a 40% reduction in Dubai World debt although it does present the total debt being restructured as being $23.5 billion with total debt after the restructuring of $14.4 billion. Nakheel's restructuring, which appears to be separate from Dubai World's restructuring, has already been approved by 50 percent of creditors, is expected to be approved by at least the 65% of creditors required within 2 weeks.

Other News

• The JAFZ sukuk is scheduled to make a distribution payment of $128 million on Thursday, May 27th.
  
• Analysts at the International Islamci Finance Forum 2010 predict that Islamic banks will manage $4 trillion in assets by 2020. This is roughly four times the current size, although statistics about the size of the industry are often unreliable.
  
• OIC countries, led by Malaysia, may launch a clean energy development bank to promote renewable energy projects in OIC-member countries.
  
• Bank Negara Malaysia governor Zeti Akhtar Aziz says that the cental bank is developing financial instruments "that will facilitate cross-border transactions by financial institutions to improve liquidity in the Islamic banking system".
  
• The Malaysia Airports Holding Bhd is planning MYR2.5 billion in sukuk and conventional bonds. The sukuk portion will be MYR1 billion.
  
• An article provides additional commentary on the newly announced sukuk from Malaysia.
  

Malaysia sovereign sukuk, Dubai World debt settlement, WIEF

Malaysia sovereign sukuk
The basics of the coming Malaysian sovereign sukuk were officially released (although the total size has not been except that it will probably be larger than the $600 million issue in 2002). The proposed sukuk received an initial rating from S&P is A-. The dollar-denominated global sukuk, issued by the government's SPV 1Malaysia Sukuk Global Bhd, will be a 5-year ijara sukuk will involve the sale and leaseback of 12 hospitals according to the CEO of HSBC Amanah, Mukhtar Hussain. The government is meeting with prospective investors and will do so until May 27th and order-taking will begin a few days later.

One of the reasons for the issue, and the primary importance of the issue for Islamic finance, is that there are few sukuk issued (only one other by Malaysia) and they provide an important benchmark for corporate issuers. The five-year maturity is short, but it is in line with the most common maturity of sukuk, so near term it will be relevant to create a pricing benchmark for short-term sukuk. However, it does not establish a sovereign benchmark for longer-term sukuk, which would have been noteworthy. However, with the European debt crisis in full swing with the yield premium for new issues (e.g. Spain today) rising, the fact that the sukuk is likely to be issued blunts some criticism of its 5-year tenor. If Malaysia wanted to continue to help the global Islamic finance industry, it should follow this 5-year sukuk with a 10- or 15-year sukuk to establish a pricing benchmark.

One concern remaining is that the sukuk will be issued in a time of rising yields among sovereign borrowers as a result of the European debt crisis and this could establish a benchmark yield higher than what might have been received six months ago or six months from now. Therefore, the Malaysian government should make an effort to ensure that this sukuk is tradable in a liquid market (Malaysian sukuk secondary markets are less liquid than conventional bond markets but more liquid than most sukuk secondary markets). That would allow secondary market activity to price the changes in a 5-year sukuk sovereign yield that would provide more transparency for pricing future corporate issuers.

Dubai World agreement
The Dubai World debt agreement surrounding $24 billion in debt has been reached in principle. The FT Alphaville blog posts the entire press release with the table describing the terms. The repayment will total $14.4 billion ($0.60 on the dollar), split into two tranches. Each tranche will be allocated pro rata to the debt claims. Tranche A will have a five-year maturity at 1% interest. Tranche B will have three options, the first two will be available for holders of USD denominated debt, while the third will be available for holders of AED denominated debt. Tranche B will have a longer maturity with shortfall guarantee for 1/2 of the $10 billion size. The interest rate will again be 1% except for AED-denominated debts when the 1% will have EIBOR-LIBOR up to 1% added in.

While it is not clear whether the debt covered will include Shari'ah-compliant debt, it does puts some firm numbers on the outcome for these lenders compared with holders of the 2010 and 2011 Nakheel sukuk, who have or will receive full repayment of all principal plus profit. Last weekend, I addressed my concern that this differential treatment could negatively affect the ability and willingness of conventional issuers to also issue sukuk and the numbers, I think, make this concern even more relevant.

World Islamic Economic Forum

• Speaking at the WIEF, Prince Andrew said that the UK, and London in particular, will continue to build on its status as the largest Western hub for Islamic finance.
  
• The new UK government may reconsider a sukuk if the value-for-money can be demonstrated; that is, will the additional source of demand and encouragement for the Islamic finance work within London offset the additional structuring costs. Assuming tax laws are changed, the UK's first corporate sukuk could be issued this year, according to Humphrey Percey, the CEO of BLME.
  
• The Malaysian central bank, Bank Negara, has established programs to educate other central banks on regulating Islamic finance.
  
• The executive vice chairman of Ithmaar Bank, Khaled Abdulla-Janahi, said that there is need for greater education among Muslims about Islamic finance and says that the history of Islamic finance in the future may regard Gordon Brown, for his work as finance minister of the UK, and Christine Lagarde, the current French finance minister, as the two biggest drivers of growth in the Islamic finance industry.
  
• Five memoranda of agreement worth $125.3 million were signed at the WIEF.
  
• The CEO of Maybank MEACP Pte Ltd, Mumtaz Khan, suggests a G3+3 group to work with the G20 to develop Islamic finance. The parties involved would be the three G20 members with Muslim majorities, Saudi Arabia, Indonesia and Turkey, in addition to Malaysia, the World Islamic Economic Forum and the Islamic Development Bank.
  

Other News

• Rushdi Siddiqui continues his excellent line of articles in Gulf News with one on the need for a global Islamic sovereign wealth fund.
  
• The head of the DFSA warns that forcing Islamic financial institutions to operate under the same regulatory rules as conventional financial institutions could hurt its growth prospects.
  
• The governor of the Reserve Bank of India says that Islamic banking cannot be licenses under current regulation, but it is still exploring whether Shari'ah-compliant non-banking financial institutions are possible.
  
• Qatar Islamic Bank is planning to sell as much as $750 million in its first sukuk issuance. The sales of sukuk so far have risen year on year at the fastest rate since 2007 (albeit from a low base) as yields have fallen more than emerging market debt.
  
• Lipper Research describes the performance of Islamic equity funds by investment area and geographical concentration. 45% of all funds are in Southeast Asia while 59% of total assets in Islamic funds are in the GCC.
  
• Dubai Islamic Bank has launched a new unsecured consumer lending product based on a salam contract with the commodity used being sugar. As I understand it, the bank would provide financing and the customer would be obligated to deliver a given amount of sugar (incorporating a markup) at the maturity. The transaction involves a sugar wholesaler that collects partial payments from the customer and at maturity will deliver the sugar to DIB.
  
• The Commercial Real Estate Sukuk (Kuwait) for $100 million was paid on its maturity date.
  
• Ireland hopes to attract Islamic financial institutions and Islamic funds to the International Services Centre in the country.
  
• The president of CIMA writes in an opinion article in The Australian newspaper that Islamic finance has significant growth potential but is still hampered by a lack of people skilled in understanding the requirements for Islamic financial products.
  

Future growth in Islamic finance, sukuk news

Future growth in Islamic finance
An article in the National newspaper provides a good summary of the growth areas in Islamic finance, as well as the areas of controversy which remain in these areas. The largest focus is on whether creating Shari'ah-compliant hedging contracts is a help or hindrance for the growth of the industry. In some aspects I can see how it reinforces the view that Islamic finance does nothing but mimic conventional financial products. However, as the article notes, longer term financing like what would be necessary for project finance, would be largely absent were there not a way to hedge against currency, commodity price or interest rate fluctuations.

The article also discusses the lack of Islamic microfinance. Moinuddin Malim, the CEO of Mashreq Al Islami, is quoted as saying "We have not yet reached our real audience. We need to develop microfiannce to enable communities to thrive in their own right and bring living standards to them". I would disagree with his characterization of "bringing living standards to them" and replace that with bring affordable, Shari'ah-compliant financial alternatives, but it is definitely an underserved area of Islamic finance. The CGAP competition which recently closed (and I advised two groups who submitted proposals) is a good effort because it focuses on providing seed money to develop sustainable financial institutions (either non-profit or for-profit). However, outside of this and a few efforts by a couple small efforts by (mostly) global financial institutions in Islamic finance, there has been not much more than lip service paid to the need for Islamic microfinance.

There is a lot more to Islamic finance than just structured products that mimic conventional finance for large corporations and sovereigns. Islamic retail banking fills some of the need with a reach towards a larger number of Muslim consumers, but there are many Muslim (and non-Muslim) 'unbanked'. This is the consumer base that the Grameen Bank was formed to serve and it has now attracted a lot of attention from larger financial institutions. The same need is present for the Islamic financial industry to fill and it should be a quicker transition for Islamic financial institutions to recognize this need (and potential) now that conventional microfinance is well established with participation from the larger financial institutions. It is also ideally suited to the underlying ethics behind Islamic finance, which should feel a greater need to promote economic empowerment based on its ethical foundations.

Another article describes the re-emergence of innovation within the Islamic financial industry which has largely been absent during the recession. There are areas--like liquidity management--where innovation can be a positive development to increase the available investment opportunities (particularly short-term and overnight). However, there are also a lot of 'innovations' during the 2005-2008 period in structured products and especially real estate, where 'innovation' can turn into 'high fees with little other benefit'. One example of this that has been described in detail was Gulf Finance House, which was described in a recent paper by Mohammed Khnifer.

The issue of standardization remains contentious. The debate, however, depends on what standardization means, which Debshis Day of Clifford Chance pointed out, is unclear. "Standardization, what does that really mean? It is very difficult for everybody to agree on one thing. People need to understand that even in a conventional market there is not pure standardization". I would agree with him that complete standardization is neither possible nor probably desirable. There are certain areas (like the ISDA-IIFM derivatives standard and the IIFM standardized murabaha agreement) where standardization can be beneficial by reducing costs associated with replicating the same structure. However, these standardized contracts are not, nor should be, mandatory. There are numerous areas where improvements can be made and leaving the door open to new products or new variations of existing products makes sense for the industry as a whole.

Sukuk News
Unicorn Investment Bank and Standard Chartered report they have mandates to work on issuance of $6 billion in sukuk this year. Reportedly, over $4 billion of this amount will be advised by Standard Chartered. An executive at HSBC, Mohammed Dawood, says that issuance of dollar-denominated sukuk may reach $5 billion, matching the previous year's total. The total issuance may be $8.5 billion, about last year's level, but far below the pre-crisis levels in 2007 and 2008. However, due to the Greek crisis and Ramadan, most issuance will be pushed into the third quarter. Al Rajhi Bank, which has been largely absent from the sukuk market due to concerns by its Shari'ah board over the compliance of the sukuk in the markets, plans to launch a sukuk with Cagamas, the Malaysian housing finance agency, in June. Indonesia recently sold $467.5 million in sukuk to the government-managed Hajj fund.

U.S. issuers could make up part of the issuance in the second half of this year or in 2011. GE Capital, which issued a $500 million sukuk last year (my summary of that sukuk) is planning a 'benchmark' sized sukuk in late 2010 or 2011, which is generally over $500 million. In addition, Unicorn Investment Bank, which has a U.S.-based private equity subsidiary UIB Capital, is working on a $250 million sukuk for a U.S.-based company. The only two sukuk issued by U.S.-based companies so far have been the East Cameron sukuk, which ended with investors owning the underlying asset after the issuer entered bankruptcy, and the 2009 GE Capital sukuk.

Another rare issuer coming to market is Malaysia, which will likely offer its first international sukuk since 2002. The sukuk, expected to be an ijara sukuk with a 5-year tenor is said to be backed by government hospital assets. The issue is reported to be a $1 billion, however, it has not been formally announced and is expected to be announced at an Islamic economic forum in Kuala Lumpur.

Robin Amlot writes an interesting review of an e-book published by Euromoney, written by Parvez Daruwalla and Shahzad Siddiqui, in Islamic Business & Finance. The e-book talks about whether the sukuk structure, and in particular sovereign sukuk, could be done better.

Article by the CEO of Gatehouse Bank

Richard Thomas, the CEO of Gatehouse Bank, an Islamic wholesale bank in the UK, has an article about Islamic finance. While in general, he speaks to the general outlook for Islamic finance globally, he makes two notable points. First, he does not fall into the "Islamic finance is immune from the crisis" trap and secondly, he acknowledges the overlap between Islamic finance and ethical/sustainable finance. He writes:

"Islamic finance has, however, been met with enormous challenges. It has not escaped the global downturn despite Islamic banks being safeguarded by the nature of their Shariah principles against exposure to subprime mortgages and the other toxic assets that have hurt the balance sheets of so many of the world’s biggest financial institutions. "
[...]
As it is, a substantial amount of business transacted in an ethical or sustainable format may qualify as Sharia compliant. This demand for products and investments, while primarily fuelled by the world’s 1.3 billion Muslims, is supporting interesting crossover products that benefit from the same ethical criteria."

Other News

• Golden Belt Sukuk holders approved the dissolution of the sukuk trust, making the sukuk holders unsecured creditors of Saad Group.
  
• The Central Bank of Bahrain's sukuk al-ijara issue was oversubscribed by 230%. The sukuk has a maturity of 182 days.
  
• Dana Gas reset the conversion rate on its sukuk according to JPMorgan Chase & Co., the calculation agent.
  
• South African investment management firm is planning on launching its products outside of its home country including within Europe.
  
• Aston Business School will launch an MSc and PhD program in Islamic banking with sponsorship from the CEO of Dubai-based Surgi Tech.
  
• Al Rajhi Steel Industries, a Saudi rebar manufacturer obtained a $196.5 billion Shari'ah-compliant bank loan to finance construction of a new plant in Jeddah.
  
• The Iraqi bank Ashur Bank is exploring offering an Islamic banking window, for which it submitted an application six months ago to the Central Bank of Iraq. 7 of Iraq's 42 banks are Islamic banks.
  

New features

In response to the feedback I received about a newsletter and receiving emails of blog post, I have added a few new features. The first is a button that will make it easy to add this blog to an RSS feed reader (like Google Reader). I have also added a place to enter email to receive posts via email. Please note, this is just beginning and I am not sure that it is yet working. Please be patient and I will ensure it is working over the next week or two.

Finally, I have added a form to sign up for a weekly newsletter that will include the previous week's blog posts in addition to some follow-up commentary about the developments in the Islamic financial industry over the past week. As soon as I can ensure the form is working, I will begin the weekly newsletter. In general, there will be no more than one email per week although in some cases, I might send out additional emails as news developes.

I hope these are useful for my readers. Any feedback is welcome (please send it to blake@sharingrisk.org).

Nakheel repays its sukuk, FT Special Report

The Nakheel restructuring discussions continue as Nakheel repays the Nakheel Development 3 sukuk for $980 million (Thursday) with assistance from the Dubai Financial Support Fund. The trade creditors of Nakheel are close to approving the deal which would pay them 40% in cash with the remainder in a "publicly traded security with a 10 percent per annum return". Previous reporting said the security would be a sukuk, which is not mentioned in the latest news. AFP reports that 50% of trade creditors have agreed to the plan; 65% approval is needed for it to be approved. One interesting piece of information contained in the article that I had not seen explicitly mentioned was that upon the approval of a restructuring plan, Nakheel would no longer be part of Dubai World and would instead be owned directly by the government of Dubai. The repayment of the Nakheel sukuk is described as a part of the debt restructuring plan for Dubai World.

The Dubai World debt restructuring is an extremely complex process with many different stakeholders with different goals. However, it appears that there has been differential treatment of various parties without regards to their seniority (excepting the initial Nakheel Development sukuk). The first Nakheel sukuk provided sukuk investors with a mortgage over the underlying (undeveloped) properties, but the trade creditors, investors in Nakheel Development 2 and 3 sukuk and the other debt holders are all unsecured creditors of either Dubai World or one of its subsidiaries. In general, a restructuring should (in my opinion) treat all unsecured creditors equally if the debt restructuring for all entities (with the exception of excluded business like DP World) is done at once. In the current deal, all investors are theoretically being repaid at par but sukuk holders receive their payment upon the scheduled maturity dates while trade creditors receive 40% cash payment with the remainder paid in the form of a tradable security and other creditors have maturities extended with a 1% interest rate being offered.

There are good reasons for some of these developments--the Dubai government recognizes that trade creditors receiving cash on their claims (at least on a portion) will help the local economy. Paying sukuk holders on the near-term maturity will avoid default. However, it is troubling for the Islamic finance industry as a whole because it could create a perception problem for the industry. In general, the products used in Islamic finance are created to mimic conventional bonds, but their robustness in cases of default is unproven. A default by Dubai World on sukuk could have ripple effects because it was viewed (incorrectly) as a quasi-sovereign issue. However, on-time repayment of the sukuk while other creditors see the maturity extended and the interest rate dropped could make companies less likely to consider sukuk.

The rationale is somewhat convoluted, but I will try to explain it. A company that uses both conventional and Islamic forms of debt finance brings a conventional unsecured, senior bond to the market. Before that bond matures, the company issues an unsecured, senior sukuk (equal in seniority with the conventional bond) to diversify its funding sources that makes up a relatively small share of the company's total debt. When the time comes to roll over the conventional bonds, the investors balk at the debt pointing to Dubai World and asking "If you run into trouble, will the sukuk certificateholders have de facto seniority over the bond holders? Will they be repaid while we wait for a debt resolution?". The prospects for the issuance of sukuk by a conventionally financed company to create investor concerns among conventional bondholders could make such a company think twice about issuing the sukuk in the first place. This would deprive the Islamic finance industry and sukuk markets of a large group of potential issuers and will slow the growth of a portion of the industry, but not just investment banks who work on the sukuk issuers. Takaful companies, for example, will see the shortage of sukuk accentuated if potential issuers do not issue sukuk for this reason.

The Financial Times has a special report on Islamic finance. Rather than try to summarize each article, I will just list the articles and recommend them all:

• "Derivatives: 'In need of robust architecture'"
  
• "Rich potential in emerging markets"
  
• "Products: Industry 'strays too far from its roots'
  
• "Hedge funds: Industry once more at centre of attention"
  
• "Malaysia: Ahead of the game in local contest
  
• "Sukuk: Sustained recovery expected in second half of the year"
  

Other News

• Differences in interpretation and the lack of enforcement powers by standardization bodies like AAOIFI could be hindering the Islamic financial industry's growth.
  
• Bahraini Islamic investment bank Elaf Bank was appointed to arrange sukuk for two Indonesian companies.
  
• Dubai Islamic Bank approved a wakala agreement with the Ministry of Finance. The wakala agreement converts a $1 billion deposit by the government that was part of efforts to shore up local banks in the wake of the debt troubles at Dubai World.
  
• An article in the UK looks at Islamic ETFs from iShares available in the UK.
  

Rushdi Siddiqui interviews four scholars, sukuk update

First, thank you to those who have responded with feedback about a possible email newsletter of blog postings (and maybe other commentary). I would appreciate any other feedback, either as a comment to this post or in an email to blake@sharingrisk.org.

I think that Rushdi Siddiqui's latest article, an interview with four prominent Shari'ah scholars, Dr. Hussain Hamid Hassan, Dr. Mohammad Daud Bakar, Yousuf Talal DeLorenzo and Dr. Mohammad Akram Laldin is one of the most important articles for everyone interested in Islamic finance to read. It contains insights into how Shari'ah scholars see their role, the role of Shari'ah governance and the integration of younger less well-known scholars into the Shari'ah advisory role. It contains the most candid reflections of Shari'ah scholars that I have seen published about their own role both as advisors to Islamic financial institutions and as teachers and mentors of the Shari'ah scholars who will someday fill their shoes.

There is a good chunk of news about sukuk from the last couple days. The forward looking news starts with a $1.9 billion sukuk issued by Saudi Electric Company, which was issued at 95 basis points over SIBOR. As I wrote about in July 2009, the last sukuk from SEC was at a significant premium (160 bps over SIBOR) compared to it's (pre-crisis) sukuk issuance which was priced at 45 bps over SIBOR. The current sukuk is still at a premium to its 2007 sukuk, but by a far smaller margin. The shrinking yield premium for highly-rated issuers could lead to other non-high-grade corporate issuers to re-enter the sukuk market. The last estimate I have seen of the sukuk pipeline (sukuk planned but not issued) from Standard & Poor's was $50 billion, which likely includes lower rated corporates waiting for yield spreads for new issuance to decline.

Issues of sovereign sukuk, both domestically and internationally, remains active with Malaysia issuing a three-year, $311 million (MYR 3 billion) Sukuk 1Malaysia 2010 for domestic investors. In the wake of the Greek debt crisis, Indonesia is trimming but not cancelling the sukuk issuance expected in June or July of this year, but reiterated guidance that it would be a "benchmark" size, which typically means at least $500 million. The previous announcement was that the sukuk would be for $750 million. The Dubai Multi Commodities Centre just redeemed its $200 million, five-year sukuk issued in May 2005 with a final $20 million repayment. The certificateholders of Nakheel's $980 million Nakheel Development 2 sukuk have been told informally that the sukuk will be repaid on time. The funds necessary to repay the sukuk are reported to have been provided by the Dubai Financial Support Fund. This could spark some controversy among other Dubai World subsidiaries' creditors groups who have not yet finalized a debt restructuring which could see the other debt maturities extended and a 1% interest rate paid to creditors.

An article tackling the oft-debated issue of standardization in Islamic finance provides a very interesting view on the issue and what the current issues raised by tawarruq and the TID v. Blom Bank case. Reuters adds a factbox about the regulation of Islamic finance globally.

PricewaterhouseCoopers raises the issue, likely to confront Asian issuers of sukuk, about whether the illiquidity (and possible fluctuations) in their currencies will hamper the development of their Islamic finance appeal outside of the region. The issue has been confronted to some degree with Indonesia's dollar-denominated global sukuk issue last year and talk about a 10-year Malaysian dollar-denominated sukuk. There should remain a focus on developing domestic markets for Islamic finance, particularly within Indonesia where Islamic finance remains less developed. However, the internationalization of Islamic finance within Southeast Asia (and potentially South Korea, Japan and China) will strengthen the industry as a whole by providing additional geographical diversification for investors in dollar (and euro and pound and yen) denominated sukuk.

Should this blog include a newsletter? Islamic venture capital

I received a suggestion from a reader this weekend for a regular email newsletter of this blog, to complement the blog itself and the ability to receive the blog posts via RSS feed. I have thought some about providing a newsletter either weekly (with the week's posts and a teaser) or an email newsletter sent out when I post a new post. However, I would appreciate reader's feedback on whether this would be useful and what the most useful frequency of email newsletter updates would be. Please comment either on this post or by emailing me at blake@sharingrisk.org

Rushdi Siddiqui's latest article in Gulf News deals with Venture Capital, specifically the lack of it within Islamic fiannce. I wholeheartedly agree with him on that point.

Lahem al-Nasser of Asharq Al-Awsat has a dream for Islamic finance:

"I have a dream that one day Islamic financial institutions will operate based on the principle of partnership rather than debt in the sense that all parties would share both risk and profit. I have a dream that Islamic financial institutions will not base profit on usury that will cause them to be weak and fragile.

"I have a dream that one day Islamic financial institutions will have clear strategies to set up important development projects in their societies in a way that contributes to reducing unemployment, increasing productivity in society, improving technology and adopting and strengthening creative ideas. I have a dream that Islamic financial institutions will create genuine products rather than alternative ones through which they could change the conventional view of the financial institution. I have a dream that the joint Islamic financial market will be based on relying on its own tools away from imitating derivatives, bonds or other tools of Islamic banking.
[...]
"I have a dream that Islamic financial corporations will be able to convey Islam's civilized message to the world just as our merchant Muslim ancestors did. I have a dream that one day Muslim businessmen will make this dream come true.

Other News

• The government of Dubai formed a committee of creditors as we enter a week that will see the maturity of one of Nakheel's sukuk (Thursday).
  
• Malaysia may sell 10-year dollar-denominated bonds in June, although it was not specified whether these would be conventional bonds or sukuk.
  
• Emirates Steel is close to receiving $2 billion in loans, of which $1.5 billion is expected to come in the form of Islamic finance facilities. The closing is expected in June.
  
• An article describes the limited clarity in takaful that has hampered the industry's growth.
  
• Nomura International plc entered into a $50 million commodity murabaha transaction as its debut transaction in Islamic finance.
  
• The Islamic Development Bank is planning to boost cooperation with India, which is not an OIC member.
  

Thursday bullets

• Saudi Electric Company cut the yield guidance on its next sukuk issuance to 95 basis points over SIBOR compared to a spread of 160 basis points over SIBOR for its last sukuk.
  
• The Asian Development Bank is considering starting a multi-billion sukuk program.
  
• Dubai World will begin not paying interest on its debts beginning this month.
  
• Yuri Asset Management received approval for the first Islamic investment fund.
  
• Bank Islam and several Middle Eastern investors are looking to invest in Bank Muamalat's rights issue.
  

DIFC template for sukuk, Islamic banks in Africa

I am disappointed that it has taken this long, but the DIFC seems poised to provide a standardized template for sukuk based on the recent IFC sukuk. The work has been labeled the "Dubai docs" in reference to the role that the DIFC is playing in providing a standardized set of sukuk documents. Until now, each sukuk has been structured individually and there is no set of documents that creates a standardized offering document so the costs, estimated at $250,000, is borne by each issuer having to build an offering document without a standard reference contract. In other countries like Pakistan, the Central Bank offers standardized contracts for basic products like murabaha and the IIFM has issued a standardized murabaha contract, as well as one for derivatives (tahawwut) with the International Swaps and Derivatives Association (ISDA). I think this will be something that spurs similar documents elsewhere in the world that will reduce the cost of sukuk issuance and encourage new issuers who would have otherwise been deterred by the cost to enter the market. This will, in particular, bring smaller issuers into the market to provide a source for a sukuk yield curve that does not just include sovereign issuers nad high-grade corporate issuers. The more the sukuk market can develop and provide a separate yield curve for sukuk issuers, the more ti will open the market up to other new issuers. The more sukuk that are issued (and especially the diversity in issuer characteristics) will provide alternative investment opportunities to holders of sukuk, which will help the secondary market develop further.

Islamic banks starting in Sub-Saharan Africa face an image problem that they are only catering to Muslims. The Central Bank of Kenya is working on a framework to issue sukuk to attract capital from the Gulf states. The Central Bank governor gave a speech recently at a conference in Nairobi, Kenya along with other representatives of Islamic banks in Kenya and other parts of Africa. The Standard Bank Group is starting to provide Islamic banking products in Tanzania. In addition, recently National Bank of Commerce launched an Islamic banking service.

Other News

• Sukuk is still a niche market and the Nakheel sukuk resolution will not revive the market. Nakheel's 2010 sukuk maturing next week will not revive the market on its own. This is expected to occur even without a restructuring agreement for Dubai World's debts, which HSBC describes as "very fair".
  
• Standard & Poor's rated an Islamic fund, its first such rating. The fund is offered by European Finance House.
  
• Lebanon is not planning to offer a sovereign sukuk. Luxembourg, however, is considering offering a sovereign sukuk.
  
• Another article presents comments on the need for a systemic stability regulator for the Islamic financial industry.
  
• Al Baraka expects to complete the purchase of a stake in Bank Muamalat by the end of the year.
  
• Hawkamah and the American Bar Association organized a conference in Dubai on Islamic finance at the DIFC.
  
• Indonesia's ministry of finance plans to raise 1 trillion rupiah ($110.8 million) in sukuk on May 11. Several recent sukuk auctions have failed recently with investors demanding a higher yield than the ministry of finance is willing to pay.
  
• Several sukuk, including two Nakheel sukuk, have been suspended from NASDAQ Dubai for failure to file financial statements and annual reports.
  
• Cagamas and Al-Rajhi bank are cooperating to issue a sukuk recognized as being in compliance with Shari'ah globally.
  
• Malaysian firm MTD InfraPerdana issued a MYR100 million ($31.2 million sukuk).
  

Nakheel to repay maturing sukuk on May 13, equity vs debt in Islamic finance

An unnamed government spokesman says that Nakheel's sukuk maturing on May 13th even if there is no formal debt agreement according to Bloomberg. Heiko Hesse and Andy Jobst of the IMF provide their own analysis of the Nakheel situation including what I believe is the first analysis of how the issue of Shari'ah-compliance might create issues with the resolution of the company's problems (as described by the conventional thinking about the proposed debt restructuring plan. I have aired my own views in the past on this blog, but unless a Shari'ah board were to weigh in the actual impact of requiring Shari'ah-compliance for a restructuring plan cannot be known.

Kuwait Finance House Malaysia has offered several real estate financing transactions using an equity-based (mudaraba or musharaka) model, while most other banks have not. Shari'ah scholar Aznan Hasan, who I had the pleasure of hearing speak at the recent UFANA conference in Toronto, is quoted in the article saying "Whether it is debt or equity that suits you better, it depends on commercial and business decisions, not syariah matters". I would tend to agree with Aznan Hasan on this, although I my own views on the use of equity versus debt in Islamic finance has gone back and forth during the time I have written this blog.

Other News

• There are concerns over the cash levels to fund coupons and principal repayment of the Villamar sukuk, although the issuer denies there is a cash crunch.
  
• Qatar First Investment Bank raises a number of important challenges facing the Islamic financial industry.
  
• Regardless of the outcome of the UK election, the government will likely continue to encourage Islamic finance by removing barriers that make Islamic finance more difficult and costly compared with conventional finance. The official position as described by the FSA has been 'no obstacles, no special favors'.
  
• A South African private equity firm plans to extend Islamic private equity funds towards black economic empowerment (BEE) projects.
  
• Zurich Financial Services plans to enter into the takaful markets in Saudi Arabia and Malaysia.
  
• Kuwait Finance House, the country's largest Islamic bank, saw its profits fall in the first quarter of 2010 compared to the same period last year. The profits for 2009 were down significantly from 2008.
  
• A writer describes Islamic finance as instructional to provide capital on attractive terms. However, while the article is interesting and the points well made, its description of the industry bears little resemblance to how Islamic finance works in practice.