The Islamic Corporation of Investment and Export Credit (ICIEC) is not a part of the Islamic Development Bank group which receives much attention. n part, that is due to its relatively small size; its capital is only slightly higher than $200 million and its premium income was only $12.5 million during the last year. However, it provides an important service: takaful for political risks and credit risks to exporters, as well as reinsurance for its 40 member countries' Export Credit Agencies (ECAs).
During 2008/09, the ICIEC increased its authorized capital by 50% (from ID100 million to ID150 million; an Islamic Dinar [ID] is equal to one Special Drawing Right from the IMF). Recently, the ICIEC announced that it was going to increase its capital "to meet the rising demand" for its services. Before discussing the potential for the ICIEC to provide a valuable service, particular to Islamic financial institutions with cross-border operations, I'll give a short summary of what the ICIEC does.
At its core, the ICIEC is a takaful provider, but with multilateral backing from the Islamic Development Bank and its member countries (which were the reason it received a Aa3 rating from Moody's). The ICIEC writes insurance policies covering several types of products, from political risk to reinsuring export credit agencies from its member countries to export credit risk arising from non-payment by customers to which a company exports its product (or a company receiving a letter of credit from a financial institution).
The ICIEC receives takaful (and re-takaful) premiums from its customers and also has paid-up capital from the Islamic Development Bank and its member countries. These two sources of funds are kept segregated and accounted for separately in the financial statements (which are available as part of its annual report on its website). The insurance policies written by the ICIEC totaled $2.54 bllion in September 2010 compared with $1.2 bllion in the same period in 2009. In exchange for these insurance policies, the customers pay a down payment and a stream of monthly premiums. These go into the policyholder fund. The paid up capital is kept in the shareholders fund.
These two funds are invested in Shari'ah-compliant investments, primarily commodity murabaha with financial institutions (which the ICIEC describe as "reputable banks" and they believe "no credit loss is likely to occur"). A portion of the portfolio is invested in sukuk, equities and other investments including the IDB Unit Investments Fund. The profits from these investments (in the policyholder's fund), along with current premiums are used to cover claims and operating expenses (with the exception of the management fee paid to the IDB for its management of the shareholders' fund). Any excess is carried forward as a reserve against future losses. If the losses plus operating expenses deplete the policyholder's fund, the shareholder's fund provides a qard hasan loan to the policyholder's fund. These loans are repaid based only on future surplus in the policyholder's fund. In addition, when a claim is paid, the ICIEC recovers what it can from the defaulting party, which offsets the cost of the claim.
Now, we return to the significance of the ICIEC move to expand its capital to finance the growth in business. When businesses that want to avoid conventional export credit and political risk insurance, they have two options: the ICIEC and a private sector insurer. Because of the backing from member countries and the IDB, the ICIEC has relatively less counterparty risk than a non-multilateral insurer. This should encourage greater cross-border flows, either through direct investment (FDI) or export activities.
This insurance is not limited to goods-producing industries; it can support Islamic financial institutions' expansion across borders as well by reducing certain risks of moving outside the bank's home country. There seems to be a growing harmonization of Shari'ah standards between the GCC and Malaysia (for example the Cagamas-Al Rajhi Bank Sukuk ALIM) and the growth of Malaysian Islamic banks outside of Malaysia (for example, into Indonesia). Both should support the growth in demand for the ICIEC takaful product.
In addition, there has been a lack of connection between the global halal industry and the Islamic finance industry, something that has been well articulated by Rushdi Siddiqui among others. Growth by the ICIEC could provide a way for the global halal industry to connect and recognize the benefits from the Islamic finance industry. This is more likely now that the ICIEC has begun providing export credit insurance for companies in member countries exporting to non-member countries.
The way for the Islamic finance industry and the halal industries to become familiar with one another is not necessarily through large sukuk, expensively created by Islamic banks, but the more mundane support that the export credit takaful can provide. Expanding the capital of the ICIEC to support its growth should help.
Wednesday, December 29, 2010
Sunday, December 26, 2010
Social Media and Islamic Finance
NOTE: This is the latest commentary I provide to the readers of my weekly email newsletter. You can sign up for it by entering your email on the left side of my blog:
I wrote a blog post a few weeks ago about the role social media can play in the industry's growth if it were used more widely by Islamic finance institutions. To follow up on that post, I thought it would be useful to look at the other ways that Islamic finance can benefit from social media, primarily blogs.
There are a number of blogs focused on Islamic finance out there, including my own. Some of them provide opinion and commentary on Islamic finance or provide readers with selections of academic and corporate research on the Islamic finance industry. Others provide news updates on Islamic finance, for example by republishing articles on Islamic finance. In addition, there are areas where people come together to discuss the Islamic finance industry like the LinkedIn groups.
My primary reason for writing this follow up post to my earlier post was that I believe there could be better use of social media by people within Islamic finance and those with an interest in the field that could serve to broaden the number of people with exposure to Islamic finance. To someone without any exposure to the broad use of social media relating to Islamic finance, there appear to be few connections between the people who do participate in social media: analysis blogs have few comments, others have news, but no commentary and the dialogue that takes place on LinkedIn or the email listservs are largely invisible to people who have not joined the groups.
Someone who finds a blog either by being sent a link in an email or in a web search might read with interest, but not be able to tell whether the other readers (perhaps with greater experience in Islamic finance) support the opinion expressed by one author and would have trouble finding another place where the topic is discussed with ease. Or, a regular reader of a blog might come across it and start a conversation in another forum. However, unless the blogger is also a part of those forum, it is difficult for the blogger to react to criticism, clear up misunderstandings or even realize that something he wrote was wrong.
I am not suggesting that each blog should be a self-contained source of information and discussion on a topic; even if I believed that (which I do not), it would be futile to suggest moving towards that end. However, there are some ways in which dispersed discussions can be counterproductive. Specifically, if content and comments do not overlap in one place, it ultimately disrupts the conversation between bloggers and readers, one of the key differences between the blogging format and the opinion pages of newspapers (where there is more of a one way street from authors to readers with less dialogue). It also removes the 'social' from social media.
There is no solution that I or anyone else in particular could or should dictate. However, I have a few suggestions (speaking to everyone, but no one in particular).
1) If you find something wrong, or something you disagree with on a blog you read on Islamic finance, write a comment on the blog.
2) If you agree with a blogger or other commenter, but think they missed some aspect, write a comment on the blog.
3) If you see an interesting discussion somewhere else about a blog post that adds something to the point the blogger was making, write a comment on the blog with a link to the discussion.
4) If you think that a blogger misses something big with regularity, write a comment on the blog and start your own blog about that area.
5) If you want to write a blog, but cannot because you don't have the time or are prohibited by the company you work for, drop a blogger an email and suggest topics that you see missing, but think are important. The blogger may not write about everything you want or in the way you want it written, but most bloggers will consider ideas if they are something the blogger hasn't thought of before that fit in with the subject of the blog.
6) If you write a blog that provides news on a topic in Islamic finance, don't be afraid to add your own commentary on the subject and post a link to it in a comment on related blog posts of other bloggers.
Social media is a relatively new area of communication and, particularly within new areas like Islamic finance, are still at an early stage. However, for a young industry spread globally, they can be a valuable tool to introduce the industry to people who might not been exposed and to allow people involved with it to collaborate regardless of where they are located. Social media has room to grow across the Islamic finance industry. It cannot be just the financial institutions. Consumers, researchers and practitioners must also add their voices to make social media more valuable to the industry's growth and development.
I wrote a blog post a few weeks ago about the role social media can play in the industry's growth if it were used more widely by Islamic finance institutions. To follow up on that post, I thought it would be useful to look at the other ways that Islamic finance can benefit from social media, primarily blogs.
There are a number of blogs focused on Islamic finance out there, including my own. Some of them provide opinion and commentary on Islamic finance or provide readers with selections of academic and corporate research on the Islamic finance industry. Others provide news updates on Islamic finance, for example by republishing articles on Islamic finance. In addition, there are areas where people come together to discuss the Islamic finance industry like the LinkedIn groups.
My primary reason for writing this follow up post to my earlier post was that I believe there could be better use of social media by people within Islamic finance and those with an interest in the field that could serve to broaden the number of people with exposure to Islamic finance. To someone without any exposure to the broad use of social media relating to Islamic finance, there appear to be few connections between the people who do participate in social media: analysis blogs have few comments, others have news, but no commentary and the dialogue that takes place on LinkedIn or the email listservs are largely invisible to people who have not joined the groups.
Someone who finds a blog either by being sent a link in an email or in a web search might read with interest, but not be able to tell whether the other readers (perhaps with greater experience in Islamic finance) support the opinion expressed by one author and would have trouble finding another place where the topic is discussed with ease. Or, a regular reader of a blog might come across it and start a conversation in another forum. However, unless the blogger is also a part of those forum, it is difficult for the blogger to react to criticism, clear up misunderstandings or even realize that something he wrote was wrong.
I am not suggesting that each blog should be a self-contained source of information and discussion on a topic; even if I believed that (which I do not), it would be futile to suggest moving towards that end. However, there are some ways in which dispersed discussions can be counterproductive. Specifically, if content and comments do not overlap in one place, it ultimately disrupts the conversation between bloggers and readers, one of the key differences between the blogging format and the opinion pages of newspapers (where there is more of a one way street from authors to readers with less dialogue). It also removes the 'social' from social media.
There is no solution that I or anyone else in particular could or should dictate. However, I have a few suggestions (speaking to everyone, but no one in particular).
1) If you find something wrong, or something you disagree with on a blog you read on Islamic finance, write a comment on the blog.
2) If you agree with a blogger or other commenter, but think they missed some aspect, write a comment on the blog.
3) If you see an interesting discussion somewhere else about a blog post that adds something to the point the blogger was making, write a comment on the blog with a link to the discussion.
4) If you think that a blogger misses something big with regularity, write a comment on the blog and start your own blog about that area.
5) If you want to write a blog, but cannot because you don't have the time or are prohibited by the company you work for, drop a blogger an email and suggest topics that you see missing, but think are important. The blogger may not write about everything you want or in the way you want it written, but most bloggers will consider ideas if they are something the blogger hasn't thought of before that fit in with the subject of the blog.
6) If you write a blog that provides news on a topic in Islamic finance, don't be afraid to add your own commentary on the subject and post a link to it in a comment on related blog posts of other bloggers.
Social media is a relatively new area of communication and, particularly within new areas like Islamic finance, are still at an early stage. However, for a young industry spread globally, they can be a valuable tool to introduce the industry to people who might not been exposed and to allow people involved with it to collaborate regardless of where they are located. Social media has room to grow across the Islamic finance industry. It cannot be just the financial institutions. Consumers, researchers and practitioners must also add their voices to make social media more valuable to the industry's growth and development.
Wednesday, December 22, 2010
What is wrong with GCC sukuk markets?
Coming up to the end of the year, it is time to reflect back on the year just past and look forward to 2011. Kuwait Finance House Research prepared a report, which is summarized in a press release, which predicts that issuance in 2011 will surpass the $34 billion issued at the peak in 2007 (issuance in 2010 is estimated to be almost equal to the 2007 level). To avoid just repeating the KFHR report (I would suggest reading the press release summary) I will offer my own thoughts using a few of the statistics in the report.
First, there have been two themes in 2010 sukuk issuance: 1) sovereign issues; and, 2) the move eastward with GCC issuers tapping the markets in Malaysia instead of the domestic market (either through local currency issues or global USD issues). This is a mixed bag. It certainly aids the development of a more harmonized market for sukuk in terms of Shari'ah standards as GCC issuers are becoming familiar with Malaysian Shari'ah standards and tailoring their sukuk issued in Malaysia to the local market, while also issuing some sukuk in the GCC as well.
However, the move eastward by GCC issuers is also exaggerating the disparity between primary markets for sukuk in Malaysia and the GCC. Malaysia's GDP in 2009 was $193 billion compared with Saudi Arabia's GDP of $369 billion in the same year and the GCC as a whole representing $912 billion in GDP in 2009. Yet, sukuk issuance in Malaysia makes up 72.3% of the entire sukuk market in the first nine months of 2010 (9M10). There is also concentration of certain issuers: sovereigns make up 77.3% of issuers in 9M10 while financial services issuers (which make up a large proportion of conventional bond issuers) represented only 9.8% with utilities issuing 7.6% of sukuk issued.
The sukuk markets should ideally be representative of the size of the total market (measured by GDP) because they should finance real economic activity (at least if the spin from the press releases are to be believed). They should also be in proportion to the Muslim population of the countries they come from because the primary reason they exist is to provide a Shari'ah-compliant alternative to conventional bonds for both Shari'ah-sensitive investors and issuers. On both marks, the current sukuk market structure fails. Malaysia's GDP is roughly 20% of the GCC GDP. Malaysia also has a large non-Muslim population (40% according to Wikipedia, citing the Malaysian census).
Let's look at what the sukuk market should be in the GCC based on Malaysia, using a very rough approximation with many flaws. I use the following numbers to get a rough approximation: relative GDP of Malaysia to the GCC of 20%, the Muslim populations in Malaysia (60%) and GCC (assuming 90% Muslim population in the GCC) and the KFHR estimate of $34 billion in sukuk issued (or $24.5 billion originating from Malaysia). Adjusting for the differences in Muslim population and relative GDP, there should have been $184.4 billion in sukuk issuance in the GCC (taking the sukuk in Malaysia, dividing by the Muslim share of the population, dividing by the relative GDP of Malaysia and multiplying by my estimate of the Muslim population of the GCC). This leaves $175 billion in missing sukuk from the GCC assuming that all the non-Malaysian sukuk were issued in the GCC.
This number is essentially made up, but is based on a rough estimate about the potential for the sukuk markets in the GCC, if it were pulling its weight with Malaysia in terms of GDP and the Muslim population. It can be discounted heavily to adjust for my estimation process and still leaves a large number relative to the total sukuk issuance of 2010. There are two conflicting reasons for the gap. First, one of the primary uses for sukuk is to fill the need for high-grade, government or corporates of similar quality bonds to fill the portfolios of pension funds, takaful funds and for banks to earn a relatively safe return with their surplus funds. Second, many investors in the GCC and elsewhere would like to be able to include a sukuk component in their overall portfolio, but will hesitate if they are not able to change the components of that portfolio quickly with changing market conditions (or their own need for liquidity).
These two forces are pulling at each other, but generally the former is dominating. Sukuk are issued and snapped up by hold-to-maturity investors. There is a small, illiquid secondary market for sukuk and those markets were hit sharply by the Dubai debt crisis. Despite representing a small part of the GCC, the issuance from Dubai entities and other UAE issuers (who were caught up in the lack of confidence among investors) represented a large share of the GCC sukuk issuance in the boom years. This confidence will not be restored quickly and therefore issuers have either retreated from the market altogether (or fled to Malaysia) or focused their issuance on hold-to-maturity issues.
However, this serves to limit the size of the corporate sukuk market in the GCC and ultimately will hurt the hold-to-maturity investors, as it has already deprived the investors needing liquidity of many investment options. The flood of GCC issuers looking to Malaysia is making the problem more imminent as redeemed and defaulted sukuk are not being replaced by new sukuk issued in the GCC in a currency that does not create currency risk for local issuers (whose home currency is tied to the dollar, which is depreciating against the Ringgit, but which may reverse).
All the parties involved, from issues in the GCC, hold-to-maturity investors and investors seeking a liquid, fixed income investment, all need more local issuance. Issuers need a competitive pricing environment with no currency risk (at least until Shari'ah-compliant currency hedging becomes more common and less "new"). Whatever it takes for GCC countries to attract more issuance, they should do or else sukuk may become a Malaysian phenomenon, despite a size advantage in terms both of Muslim population and GDP held by the GCC.
Until the GCC markets are "fixed" (or an alternative market like the Luxembourg Stock Exchange becomes the go-to location for sukuk issuers), there will continue to be a large gap even in "one of the main components of the Islamic financial system" as KFH Research called the sukuk market.
First, there have been two themes in 2010 sukuk issuance: 1) sovereign issues; and, 2) the move eastward with GCC issuers tapping the markets in Malaysia instead of the domestic market (either through local currency issues or global USD issues). This is a mixed bag. It certainly aids the development of a more harmonized market for sukuk in terms of Shari'ah standards as GCC issuers are becoming familiar with Malaysian Shari'ah standards and tailoring their sukuk issued in Malaysia to the local market, while also issuing some sukuk in the GCC as well.
However, the move eastward by GCC issuers is also exaggerating the disparity between primary markets for sukuk in Malaysia and the GCC. Malaysia's GDP in 2009 was $193 billion compared with Saudi Arabia's GDP of $369 billion in the same year and the GCC as a whole representing $912 billion in GDP in 2009. Yet, sukuk issuance in Malaysia makes up 72.3% of the entire sukuk market in the first nine months of 2010 (9M10). There is also concentration of certain issuers: sovereigns make up 77.3% of issuers in 9M10 while financial services issuers (which make up a large proportion of conventional bond issuers) represented only 9.8% with utilities issuing 7.6% of sukuk issued.
The sukuk markets should ideally be representative of the size of the total market (measured by GDP) because they should finance real economic activity (at least if the spin from the press releases are to be believed). They should also be in proportion to the Muslim population of the countries they come from because the primary reason they exist is to provide a Shari'ah-compliant alternative to conventional bonds for both Shari'ah-sensitive investors and issuers. On both marks, the current sukuk market structure fails. Malaysia's GDP is roughly 20% of the GCC GDP. Malaysia also has a large non-Muslim population (40% according to Wikipedia, citing the Malaysian census).
Let's look at what the sukuk market should be in the GCC based on Malaysia, using a very rough approximation with many flaws. I use the following numbers to get a rough approximation: relative GDP of Malaysia to the GCC of 20%, the Muslim populations in Malaysia (60%) and GCC (assuming 90% Muslim population in the GCC) and the KFHR estimate of $34 billion in sukuk issued (or $24.5 billion originating from Malaysia). Adjusting for the differences in Muslim population and relative GDP, there should have been $184.4 billion in sukuk issuance in the GCC (taking the sukuk in Malaysia, dividing by the Muslim share of the population, dividing by the relative GDP of Malaysia and multiplying by my estimate of the Muslim population of the GCC). This leaves $175 billion in missing sukuk from the GCC assuming that all the non-Malaysian sukuk were issued in the GCC.
This number is essentially made up, but is based on a rough estimate about the potential for the sukuk markets in the GCC, if it were pulling its weight with Malaysia in terms of GDP and the Muslim population. It can be discounted heavily to adjust for my estimation process and still leaves a large number relative to the total sukuk issuance of 2010. There are two conflicting reasons for the gap. First, one of the primary uses for sukuk is to fill the need for high-grade, government or corporates of similar quality bonds to fill the portfolios of pension funds, takaful funds and for banks to earn a relatively safe return with their surplus funds. Second, many investors in the GCC and elsewhere would like to be able to include a sukuk component in their overall portfolio, but will hesitate if they are not able to change the components of that portfolio quickly with changing market conditions (or their own need for liquidity).
These two forces are pulling at each other, but generally the former is dominating. Sukuk are issued and snapped up by hold-to-maturity investors. There is a small, illiquid secondary market for sukuk and those markets were hit sharply by the Dubai debt crisis. Despite representing a small part of the GCC, the issuance from Dubai entities and other UAE issuers (who were caught up in the lack of confidence among investors) represented a large share of the GCC sukuk issuance in the boom years. This confidence will not be restored quickly and therefore issuers have either retreated from the market altogether (or fled to Malaysia) or focused their issuance on hold-to-maturity issues.
However, this serves to limit the size of the corporate sukuk market in the GCC and ultimately will hurt the hold-to-maturity investors, as it has already deprived the investors needing liquidity of many investment options. The flood of GCC issuers looking to Malaysia is making the problem more imminent as redeemed and defaulted sukuk are not being replaced by new sukuk issued in the GCC in a currency that does not create currency risk for local issuers (whose home currency is tied to the dollar, which is depreciating against the Ringgit, but which may reverse).
All the parties involved, from issues in the GCC, hold-to-maturity investors and investors seeking a liquid, fixed income investment, all need more local issuance. Issuers need a competitive pricing environment with no currency risk (at least until Shari'ah-compliant currency hedging becomes more common and less "new"). Whatever it takes for GCC countries to attract more issuance, they should do or else sukuk may become a Malaysian phenomenon, despite a size advantage in terms both of Muslim population and GDP held by the GCC.
Until the GCC markets are "fixed" (or an alternative market like the Luxembourg Stock Exchange becomes the go-to location for sukuk issuers), there will continue to be a large gap even in "one of the main components of the Islamic financial system" as KFH Research called the sukuk market.
Year End Survey on Islamic Finance
Rushdi Siddiqui's latest opinion piece (in Malaysia's Business Times) offers a 14 question, multiple choice quiz with some tongue-in-cheek, but with a serious point as well. As I was reading it I wrote down my own responses and I thought it was worthwhile sharing. I encourage all readers to go and see what your answers would be. It was refreshingly stimulating to go through compared with most of the "year in review" articles. It might help to have the article up in another window to glance at the other answers.
Question 1. Best source for insights into Islamic finance?
1: A. I enjoy Dr. Zeti's speeches and while blogs are good sources of information, there are far too few out there, but one notable one is the blog by the editors of the Opalesque Islamic Finance Intelligence monthly newsletter led by Bernardo Vizcaino. That blog, Islamic Finance Research who put up all kinds of research they run across in addition to the Islamic Finance Intelligence newsletter. While the surveys/reports from consultancies provide a nice data dump of information, they are generally presenting a rear-view mirror view. The FT has done the best job of covering Islamic finance in the Western media, there is sadly almost nothing valuable coming out of the US.
Question 2. For Islamic finance, 2010 may be best described as year of:
2: C/D. 2009 was the year of regrouping and reflection. Starting with the rather imperfect (but still a nice precedent for the industry, despite its flaws) resolution of East Cameron, there were many sukuk issues, followed by the new Shari'ah board standards, which are a step in the right direction, but too vague and unenforceable (in general). They (AAOIFI/IFSB and national regulators) are still trying to feel their way from having a few prominent scholars to a more professional method of Shari'ah review. There has still been cheerleading, which I always find surprising after the crisis showing that Islamic finance products were susceptible to economic recessions.
Question 3. The Islamic finance highlight for 2010 was:
3: A. The stability of Islamic banks is always at risk without the proper tools to facilitate inter-bank lending and there can't be a real repo market without short-term, high grade sukuk to underpin the IIFM proposed Shari'ah-compliant repo structure. The IILM sukuk will also avoid the possibility of a freeze up in inter-bank markets if there is an Islamic bank failure.
Question 4. Should there be an Islamic finance award for a category with different winners from different conference organisers?
4: I don't know. I'm happy to be nominated for an award (I was nominated in the IB&F Awards in the Islamic Finance Research category), but I don't know what value they add to the industry.
Question 5. Should there be an award for the most accessible syariah scholar?
5: A. I think that Shari'ah board accessibility should be encouraged, but I think there should be more fatawa available with the reasoning behind them to provide greater clarity of the Shari'ah review process. For example, the Al Baraka compilations of fatawa, although I think most of those are not current.
Question 6. Today, marketing of Islamic banking is only about reaching out to Muslims?
6: B. It could be A, but right now, Islamic finance is marketed to Muslims. There are areas where it could be appealing to non-Muslims, but not the way it is currently done. I think broadening the marketing to ethical finance at this point would be somewhat misleading because it doesn't incorporate enough positive screens.
Question 7. Islamic finance needs to reach out new channels, like social media, to reach their bankable customers?
7: B. I agree that focusing on depth is valuable, but with (6) I think the substance has to be improved to become more accessible and relevant to more people. If there was more Islamic microfinance, I would say C, but there are plenty of people with internet access who could be reached by better use of social media.
Question 8. Islamic finance needs to pay immediate attention to:
8: All except for E. Takaful is still behind the rest of Islamic finance, microfinance is nearly nonexistent. Important asset classes (and particularly access to those asset classes like sukuk funds) are left out while more complex products are developed to be the "first" or to capture higher fees. Secondary markets and treasury instruments are underdeveloped. The connection with Islamic financial products' Shari'ah-compliance is unclear in secular dispute resolution processes. I have been so busy with Islamic finance that I have not taken the time to look more into the rest of the halal industry, but it seems a natural fit to use Islamic finance to finance the halal industry and it's large enough that it could be big for Islamic finance.
Question 9. What is the biggest threat/risk to future of Islamic finance?
9: B. I think the other answers matter, but to a much lesser degree. If the industry keeps growing relying on the same 10 scholars, at some point, they will miss something in a document they approve that hits the headlines.
Question 10. Today, what are the systemic risks to Islamic finance?
10: B. I think that a depositor run without the repo markets/lender of last resort/enough liquid, high-grade investments is not just possible, but likely. It won't necessarily cause contagion, but it will hit one of the more solid areas of Islamic finance (banking).
Question 11. Research is needed immediately on:
11: A. See (10).
Question 12. In 2011, stock exchange contribution to development of Islamic finance will be from:
12: B/E. I think the flood of GCC issuers to Malaysia will make Bursa Malaysia the center of activity for a while, marginalizing some of the GCC exchanges, despite some efforts to encourage sukuk trading. I am intrigued by the participation of the central bank of Luxembourg in the IFSB and the governor's appointment as deputy chairman of the IILM. The LSE seemed to be the exchange of choice for sukuk, but the Luxembourg Stock Exchange has attracted other products that the LSE lost to Dublin.
Question 12. In 2011, stock exchange contribution to development of Islamic finance will be from:
13: A/D. I don't think that the domestic market in Malaysia will be as significant as its role in the global Islamic finance industry through the IILM and by attracting GCC issuers with its liquid sukuk secondary markets. I do worry that the strengthening MYR against the dollar could hurt GCC issuers if it continues (particularly if the MYR is above current levels when those sukuk mature).
Question 14. Qatar's victory in hosting the 2022 Fifa World Cup finals will mean:
14: C.
If you go through the survey and get different responses (or even if you agree with my picks, but think I left something out), please drop them in the comments.
Question 1. Best source for insights into Islamic finance?
1: A. I enjoy Dr. Zeti's speeches and while blogs are good sources of information, there are far too few out there, but one notable one is the blog by the editors of the Opalesque Islamic Finance Intelligence monthly newsletter led by Bernardo Vizcaino. That blog, Islamic Finance Research who put up all kinds of research they run across in addition to the Islamic Finance Intelligence newsletter. While the surveys/reports from consultancies provide a nice data dump of information, they are generally presenting a rear-view mirror view. The FT has done the best job of covering Islamic finance in the Western media, there is sadly almost nothing valuable coming out of the US.
Question 2. For Islamic finance, 2010 may be best described as year of:
2: C/D. 2009 was the year of regrouping and reflection. Starting with the rather imperfect (but still a nice precedent for the industry, despite its flaws) resolution of East Cameron, there were many sukuk issues, followed by the new Shari'ah board standards, which are a step in the right direction, but too vague and unenforceable (in general). They (AAOIFI/IFSB and national regulators) are still trying to feel their way from having a few prominent scholars to a more professional method of Shari'ah review. There has still been cheerleading, which I always find surprising after the crisis showing that Islamic finance products were susceptible to economic recessions.
Question 3. The Islamic finance highlight for 2010 was:
3: A. The stability of Islamic banks is always at risk without the proper tools to facilitate inter-bank lending and there can't be a real repo market without short-term, high grade sukuk to underpin the IIFM proposed Shari'ah-compliant repo structure. The IILM sukuk will also avoid the possibility of a freeze up in inter-bank markets if there is an Islamic bank failure.
Question 4. Should there be an Islamic finance award for a category with different winners from different conference organisers?
4: I don't know. I'm happy to be nominated for an award (I was nominated in the IB&F Awards in the Islamic Finance Research category), but I don't know what value they add to the industry.
Question 5. Should there be an award for the most accessible syariah scholar?
5: A. I think that Shari'ah board accessibility should be encouraged, but I think there should be more fatawa available with the reasoning behind them to provide greater clarity of the Shari'ah review process. For example, the Al Baraka compilations of fatawa, although I think most of those are not current.
Question 6. Today, marketing of Islamic banking is only about reaching out to Muslims?
6: B. It could be A, but right now, Islamic finance is marketed to Muslims. There are areas where it could be appealing to non-Muslims, but not the way it is currently done. I think broadening the marketing to ethical finance at this point would be somewhat misleading because it doesn't incorporate enough positive screens.
Question 7. Islamic finance needs to reach out new channels, like social media, to reach their bankable customers?
7: B. I agree that focusing on depth is valuable, but with (6) I think the substance has to be improved to become more accessible and relevant to more people. If there was more Islamic microfinance, I would say C, but there are plenty of people with internet access who could be reached by better use of social media.
Question 8. Islamic finance needs to pay immediate attention to:
8: All except for E. Takaful is still behind the rest of Islamic finance, microfinance is nearly nonexistent. Important asset classes (and particularly access to those asset classes like sukuk funds) are left out while more complex products are developed to be the "first" or to capture higher fees. Secondary markets and treasury instruments are underdeveloped. The connection with Islamic financial products' Shari'ah-compliance is unclear in secular dispute resolution processes. I have been so busy with Islamic finance that I have not taken the time to look more into the rest of the halal industry, but it seems a natural fit to use Islamic finance to finance the halal industry and it's large enough that it could be big for Islamic finance.
Question 9. What is the biggest threat/risk to future of Islamic finance?
9: B. I think the other answers matter, but to a much lesser degree. If the industry keeps growing relying on the same 10 scholars, at some point, they will miss something in a document they approve that hits the headlines.
Question 10. Today, what are the systemic risks to Islamic finance?
10: B. I think that a depositor run without the repo markets/lender of last resort/enough liquid, high-grade investments is not just possible, but likely. It won't necessarily cause contagion, but it will hit one of the more solid areas of Islamic finance (banking).
Question 11. Research is needed immediately on:
11: A. See (10).
Question 12. In 2011, stock exchange contribution to development of Islamic finance will be from:
12: B/E. I think the flood of GCC issuers to Malaysia will make Bursa Malaysia the center of activity for a while, marginalizing some of the GCC exchanges, despite some efforts to encourage sukuk trading. I am intrigued by the participation of the central bank of Luxembourg in the IFSB and the governor's appointment as deputy chairman of the IILM. The LSE seemed to be the exchange of choice for sukuk, but the Luxembourg Stock Exchange has attracted other products that the LSE lost to Dublin.
Question 12. In 2011, stock exchange contribution to development of Islamic finance will be from:
13: A/D. I don't think that the domestic market in Malaysia will be as significant as its role in the global Islamic finance industry through the IILM and by attracting GCC issuers with its liquid sukuk secondary markets. I do worry that the strengthening MYR against the dollar could hurt GCC issuers if it continues (particularly if the MYR is above current levels when those sukuk mature).
Question 14. Qatar's victory in hosting the 2022 Fifa World Cup finals will mean:
14: C.
If you go through the survey and get different responses (or even if you agree with my picks, but think I left something out), please drop them in the comments.
Wednesday, December 15, 2010
IILM appointments
I don't generally post press releases, but I think the appointments by the International Islamic Liquidity Management Center are important. I have two brief comments. The Shari'ah board of six scholars is not the "top 6" well known names in the industry, which I think is positive because it includes two top scholars, Sh. Elgari and Daud Bakar with other scholars whom I have not run across before. My other comment is that it was expected that Zeti Akhtar Aziz would be the chairperson of the IILM board because the institution is headquartered in Malaysia. However, I thought it was interesting that the deputy is the Yves Mersch, governor of the central bank of Luxembourg. Luxembourg is the only European member of the IFSB (which was responsible for the creation of the IILM). I don't have time to dig more into the press release, so here it is:
[Kuala Lumpur & Jeddah, 13 December 2010 / 7 Muharam 1432] - The International Islamic Liquidity Management Corporation (IILM) wishes to announce the appointment of Mr. Mahmoud AbuShamma as its first Chief Executive Officer (CEO) for a three-year tenure effective 1 February 2011.
Prior to his appointment at the IILM, Mr. Mahmoud has served as the Global Head of HSBC Amanah Coverage at HSBC Bank Middle East Limited, Dubai in charge of critical HSBC Amanah relationships globally, including Governments, high networth individuals and top corporate clients. He was instrumental in establishing the HSBC Amanah Syariah unit - the first foreign bank to open an Islamic retail banking unit in Indonesia, and served as its Head from 2003 to 2010. In London, he established and headed the HSBC's Islamic Treasury Unit and originated the first Islamic Syndication by HSBC Amanah.
Mr. Mahmoud will lead a team of Islamic finance experts and professionals to operationalise the IILM's mandates particularly to issue highly rated short-term Shariah-compliant financial instruments in major reserve currencies and to develop platform to enhance cross-border Islamic finance activities. With his relevant global working experience and networks, Mr. Mahmoud and his team will be responsible in meeting IILM's objectives to facilitate cross-border liquidity management and to foster regional and international co-operation in building robust liquidity management infrastructures.
As the CEO, Mr. Mahmoud will report to the IILM's Governing Board which will set its strategic policy direction and to the Board Executive Committee for its general conduct of operations. The members of the IILM's Governing are governors of its central bank and regulatory agencies members as well as presidents of its multi-lateral institution members. The IILM's Board Executive Committee, which comprises Governing Board members or their senior representatives, is delegated by the Governing Board to have an overview on the IILM operations and its members. This governance structure will also ensure strategic consultation with members of the IILM on a regular and collaborative basis.
The IILM also wishes to announce the appointment of Her Excellency Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, as the first Chairperson of its Governing Board and His Excellency Yves Mersch, Governor of the Central Bank of Luxembourg, as the Deputy Chairperson. The offices of the Chairperson and the Deputy Chairperson will be rotated annually amongst the IILM's shareholders in accordance to the Articles of Agreement of the IILM. Her Excellency Dr Zeti Akhtar Aziz has been appointed as the Chairperson of the IILM's Board Executive Committee.
The Governing Board of the IILM has appointed six internationally-renowned scholars to sit on its Shariah Committee. The Shariah Committee will decide on any Shariah issues relating to business, operations or activities of the IILM, its subsidiaries, special purpose entities or trusts. The appointed scholars who will serve for a three-year tenure are as follows (in alphabetical order):
1. Dr. Ahmed Ali Abdalla Hamad
2. Mr. Cecep Maskanul Hakim
3. Dr. Mohamed Ali Elgari
4. Dr. Mohd Daud Bakar
5. Dr. Umar Bashir Aliyu
6. Dr. Waleed Bin Hady Al Mullah
International Islamic Liquidity Management Corporation
13 December 2010
About the IILM
The IILM is an international entity established to issue short-term Shariah-compliant financial instruments to facilitate more efficient liquidity management for institutions offering Islamic financial services (IIFS) and to support the increasing cross-border transactions between IIFS. Its membership is opened to central banks, monetary authorities, financial regulatory authorities, government ministries or agencies that have regulatory oversight on finance or trade and commerce; and multi-lateral organisations which will hold shares of the IILM. The IILM was established on 25 October 2010 with 14 founding shareholders (consisting of twelve central banks or monetary authorities of Indonesia, Iran, Kuwait, Luxembourg, Malaysia, Mauritius, Nigeria, Qatar, Saudi Arabia, Sudan, Turkey, and the United Arab Emirates) and two multi-lateral institutions (the Islamic Development Bank and the Islamic Corporation for the Development of the Private Sector). Its head office is located in Kuala Lumpur and a dedicated legislation is being discussed in Malaysia's Parliament to accord the IILM with special status, privileges and immunities. For further details about the IILM, please contact:
Chairperson of the Governing Board
International Islamic Liquidity Management Corporation
Level 40
Tower 2, Petronas Twin Tower
Kuala Lumpur City Centre
50088, Kuala Lumpur
Malaysia
Telephone : +603-2168 4277
Facsimile : +603-2168 4677
E-mail enquiry can be sent to the IILM's temporary administrative secretariat (e-mail address: hizzad@bnm.gov.my (for the attention of Mr. Ahmad Hizzad Baharuddin)).
Tuesday, December 14, 2010
Trouble in the GCC sukuk markets?
A couple news articles caught my eye and tie in with my forthcoming column in Business Islamica that expands on my analysis of the article about the equity market reactions to sukuk issuance by Malaysian companies (compared with issuance of conventional bonds). The thrust of that post was whether sukuk may become marginalized if lower quality issuers dominate the primary market for sukuk (answer: yes, it could). Another post I wrote explored whether GCC issuers are looking to Malaysia for new issuance. This could create a negative feedback cycle in GCC sukuk markets as sukuk mature or default; if there are not new issuance to replace them, it could negatively impact the already low level of secondary market liquidity in sukuk.
Before setting out on what may be a gloomy outlook, I want to point out that there are positive signs just from the last few days about the sukuk markets in the GCC. Although the National Bank of Abu Dhabi announced plans to return to the Malaysian market with a sukuk issuance, Saudi firm Sipchem is planning at least a $400 million (SAR 1.5 billion) sukuk and GE Capital is planning a follow-on sukuk to its benchmark $500 million issuance from 2009. These should calm fears that GCC (and global) issuers are fleeing the GCC sukuk markets en masse.
Despite the petro-liquidity that continues to be generated in the GCC with oil prices between $80 and $90 per barrel, there are worrying signs for the sukuk markets' future development. First, the liquidity situation is not really improving despite a rebound in the economy. On this front, Malaysia has seen issuance fall in 2010 compared with 2009 (MYR18.9 billion in the first three quarters of 2010 versus MYR32.3 billion for the full year of 2009), as has the GCC. However, a decline in sukuk issuance from 2009 (which trailed the peak year of 2007) is worrying. If Islamic finance is to recover from the financial crisis, the wave of defaults in sukuk as well as the Dubai debt crisis (which was mostly conventional, but was triggered by the near-default of the Nakheel sukuk) it needs to grow strongly towards the 2007 levels each year. Instead, there was a rebound in 2009, likely caused by issuers who had postponed issues in 2008 entering the market as things subsided followed by a drop in 2010.
There have also been very few sukuk issued by high-grade corporates, with a few exceptions. The bulk of the issuance has come from sovereigns with a few high-yield issuers like Dar Al Arkan, which may be selling assets to meet its maturing debts. The investment grade corporate issuance of sukuk should be the focal point because it provides the middle ground of higher yields than sovereign issues, less risk than high-yield and should represent a significant share of the portfolios of institutional investors. For Shari'ah-sensitive investors, the lack of a liquid market for corporate sukuk leaves a pillar of asset allocation unfulfilled. In the current low rate environment, sukuk may look unattractive for issuers given their illiquidity premium and high structuring costs compared to conventional bonds, but seeing sukuk issuance move from the GCC market to Malaysia will only make it harder for institutional investors to create well diversified portfolios that do not have the currency risk associated with investing in sukuk issued in Malaysian ringgit.
I don't have an answer for what can make the markets for sukuk in the GCC become more appealing for issuers, and so the outlook is gloomy as I stated from the beginning of the post. Things change and this post may reflect a temporary preference by some GCC issuers to tap the hot Malaysian market based on its appreciating currency. However, even if the ringgit weakens against the dollar (the currency that most GCC currencies are linked to) the illiquidity of the GCC sukuk markets will continue to make it more difficult for issuers to make a competitive argument for a sukuk versus a conventional bond as they pay not just the structuring cost that would be required for any sukuk issue, but an illiquidity premium for a GCC-based sukuk issuance. And that trend continuing could cripple the GCC market for sukuk leaving mostly the high-yield or sovereign issuers.
Before setting out on what may be a gloomy outlook, I want to point out that there are positive signs just from the last few days about the sukuk markets in the GCC. Although the National Bank of Abu Dhabi announced plans to return to the Malaysian market with a sukuk issuance, Saudi firm Sipchem is planning at least a $400 million (SAR 1.5 billion) sukuk and GE Capital is planning a follow-on sukuk to its benchmark $500 million issuance from 2009. These should calm fears that GCC (and global) issuers are fleeing the GCC sukuk markets en masse.
Despite the petro-liquidity that continues to be generated in the GCC with oil prices between $80 and $90 per barrel, there are worrying signs for the sukuk markets' future development. First, the liquidity situation is not really improving despite a rebound in the economy. On this front, Malaysia has seen issuance fall in 2010 compared with 2009 (MYR18.9 billion in the first three quarters of 2010 versus MYR32.3 billion for the full year of 2009), as has the GCC. However, a decline in sukuk issuance from 2009 (which trailed the peak year of 2007) is worrying. If Islamic finance is to recover from the financial crisis, the wave of defaults in sukuk as well as the Dubai debt crisis (which was mostly conventional, but was triggered by the near-default of the Nakheel sukuk) it needs to grow strongly towards the 2007 levels each year. Instead, there was a rebound in 2009, likely caused by issuers who had postponed issues in 2008 entering the market as things subsided followed by a drop in 2010.
There have also been very few sukuk issued by high-grade corporates, with a few exceptions. The bulk of the issuance has come from sovereigns with a few high-yield issuers like Dar Al Arkan, which may be selling assets to meet its maturing debts. The investment grade corporate issuance of sukuk should be the focal point because it provides the middle ground of higher yields than sovereign issues, less risk than high-yield and should represent a significant share of the portfolios of institutional investors. For Shari'ah-sensitive investors, the lack of a liquid market for corporate sukuk leaves a pillar of asset allocation unfulfilled. In the current low rate environment, sukuk may look unattractive for issuers given their illiquidity premium and high structuring costs compared to conventional bonds, but seeing sukuk issuance move from the GCC market to Malaysia will only make it harder for institutional investors to create well diversified portfolios that do not have the currency risk associated with investing in sukuk issued in Malaysian ringgit.
I don't have an answer for what can make the markets for sukuk in the GCC become more appealing for issuers, and so the outlook is gloomy as I stated from the beginning of the post. Things change and this post may reflect a temporary preference by some GCC issuers to tap the hot Malaysian market based on its appreciating currency. However, even if the ringgit weakens against the dollar (the currency that most GCC currencies are linked to) the illiquidity of the GCC sukuk markets will continue to make it more difficult for issuers to make a competitive argument for a sukuk versus a conventional bond as they pay not just the structuring cost that would be required for any sukuk issue, but an illiquidity premium for a GCC-based sukuk issuance. And that trend continuing could cripple the GCC market for sukuk leaving mostly the high-yield or sovereign issuers.
Saturday, December 11, 2010
Islamic Finance Advocacy
There have been many attempts to change tax laws in non-Muslim majority countries like the UK, France and South Korea and in some (UK and likely France soon) these have been successful. But, South Korea's parliament again failed to pass the law with opposition from some Christian lawmakers who fear that recognizing the Islamic restrictions on interest would be against the country's constitution. I don't know enough (anything) about the South Korean constitution to know whether that is the case, but it is clearly at least to some degree based on a general Islamophobia because opponents also expressed fear that the Islamic financial products could result in funds being funnelled to terrorist groups.
Despite the fact that there is no basis for the belief that Islamic finance supports terrorism (Islamic banks and financial institutions are subject to the same restrictions on funding terrorism and being involved with money laundering), it does highlight the difficulty of expanding Islamic finance beyond the Muslim market. Similar baseless fears have led to laws banning "Shari'ah" in Oklahoma, which Haider Ala Hamoudi tried to understand on his blog Islamic Law in Our Times.
Some have called for Islamic finance to drop the 'Islamic' part of its name and the use of Arabic terms (which I have criticized on my blog). This would not do anything to defuse those who believe Islamic finance is somehow a nerfarious attempt to "impose Shari'ah law" in the West. It is likely that there is nothing that can be done to convince these critics that Islamic finance is either benign or beneficial. However, these instances where the general public on its own or through politicians take a broad brush to anything 'Islamic' suggest that there is not wide enough understanding about Islam in general or Islamic finance in particular.
I don't have a solution to approach the anti-Islamic finance crowd, but I think that there should be more of an effort by the Islamic finance industry, particularly from institutions outside of Muslim majority countries to become more active in explaining Islamic finance to the general public. Of course, these institutions are more than willing to explain to potential customers how Islamic finance works, but I think that is not enough. The industry needs to have some broader outreach to ensure that the dialogue is not defined by the opponents of Islam in general or Islamic finance in particular.
A cursory Google search turns up no Islamic finance advocacy groups. With all of the resources being applied to developing Islamic finance, particularly outside of the traditional regions where it has thrived like the GCC and Malaysia, it seems problematic that there is no group out there committed to explaining Islamic finance to the public. There are many spokespeople who can articulate the reasons why Islamic finance exists, how it works and why it is not the threat that some people claim. However, most of these people simply do not have the time to make a concerted effort to explain it to a wider audience because they are involved in tackling the most pressing issues in Islamic finance. If Islamic financial institutions truly want to broaden their market beyond Muslims, this should be one of the first things to set up. However, the benefits will accrue to the industry as a whole, so it is in no one institution's benefits to commit the resources to this important task. Therefore it is imperative for Islamic financial institutions to work together through an independent group to coordinate activities.
Despite the fact that there is no basis for the belief that Islamic finance supports terrorism (Islamic banks and financial institutions are subject to the same restrictions on funding terrorism and being involved with money laundering), it does highlight the difficulty of expanding Islamic finance beyond the Muslim market. Similar baseless fears have led to laws banning "Shari'ah" in Oklahoma, which Haider Ala Hamoudi tried to understand on his blog Islamic Law in Our Times.
Some have called for Islamic finance to drop the 'Islamic' part of its name and the use of Arabic terms (which I have criticized on my blog). This would not do anything to defuse those who believe Islamic finance is somehow a nerfarious attempt to "impose Shari'ah law" in the West. It is likely that there is nothing that can be done to convince these critics that Islamic finance is either benign or beneficial. However, these instances where the general public on its own or through politicians take a broad brush to anything 'Islamic' suggest that there is not wide enough understanding about Islam in general or Islamic finance in particular.
I don't have a solution to approach the anti-Islamic finance crowd, but I think that there should be more of an effort by the Islamic finance industry, particularly from institutions outside of Muslim majority countries to become more active in explaining Islamic finance to the general public. Of course, these institutions are more than willing to explain to potential customers how Islamic finance works, but I think that is not enough. The industry needs to have some broader outreach to ensure that the dialogue is not defined by the opponents of Islam in general or Islamic finance in particular.
A cursory Google search turns up no Islamic finance advocacy groups. With all of the resources being applied to developing Islamic finance, particularly outside of the traditional regions where it has thrived like the GCC and Malaysia, it seems problematic that there is no group out there committed to explaining Islamic finance to the public. There are many spokespeople who can articulate the reasons why Islamic finance exists, how it works and why it is not the threat that some people claim. However, most of these people simply do not have the time to make a concerted effort to explain it to a wider audience because they are involved in tackling the most pressing issues in Islamic finance. If Islamic financial institutions truly want to broaden their market beyond Muslims, this should be one of the first things to set up. However, the benefits will accrue to the industry as a whole, so it is in no one institution's benefits to commit the resources to this important task. Therefore it is imperative for Islamic financial institutions to work together through an independent group to coordinate activities.
GCC issuers looking to Malaysian sukuk markets
An article in Malaysian newspaper The Star describes a potentially troubling development for sukuk markets in the GCC. The article describes the growing likelihood that Gulf-based corporates will look to Malaysia when they choose to issue sukuk. The sukuk market in Malaysia (primarily denominated in Malaysian Ringgit) is much more developed than the GCC, particularly the secondary markets for sukuk. If corporates from the GCC become issuers in Malaysian markets, it would hurt the development of secondary markets in the GCC and could also cause difficulties for the GCC firms themselves depending on the direction of the dollar's value (to which most GCC countries have pegged their currencies).
The article describes that corporate issuers are issuing Ringgit-denominated sukuk to tap an investor base that is estimated at US$79 billion, much of which can only invest in Ringgit-denominated assets. This would undoubtedly be a positive for Malaysian markets and investors. Investors would have a larger prospect for diversification among sukuk issuers than they have now and the larger number of sukuk could put the secondary market development into a self-reinforcing (positive) cycle of more sukuk leading to more secondary market trading, which would then lead to more issuance.
However, exactly the same logic of a self-reinforcing cycle could start in the GCC with fewer sukuk being issued in the GCC, which would lead the secondary market to become squeezed for new issuance to make up to redeemed or defaulted sukuk. This would see a contraction in the already small trading volumes of sukuk, which would further limit the supply of new sukuk.
Another potential problem this could create for GCC-based issuers of sukuk is that they would have exposure to exchange rate risk. This could be a positive for those issuers with a significant share of revenues and expenses denominated in Ringgit. These issuers would then have debt payable in the same currency as their revenues, which would act as a currency hedge. However, issuers with most of their revenue denominated in USD or UAE dinar or any of the other GCC currencies that are tied to the US dollar would be at risk of having their debt service grow in local currency (USD/AED/SAR) terms if the Malaysian Ringgit appreciates further against the US dollar (and effectively appreciates against GCC currencies).
It may be that the issuers of these sukuk expect the appreciation of the Ringgit against the dollar to reverse, which would lower their debt service in their local currency. However, with underdeveloped mechanisms of hedging against currency risk in a Shari'ah-compliant framework, creating mismatches between the currency where the cashflow is generated and the currency in which debt service payments are made it adds a risk that could hurt the companies that could issue sukuk within the GCC as its sukuk markets develop.
The article describes that corporate issuers are issuing Ringgit-denominated sukuk to tap an investor base that is estimated at US$79 billion, much of which can only invest in Ringgit-denominated assets. This would undoubtedly be a positive for Malaysian markets and investors. Investors would have a larger prospect for diversification among sukuk issuers than they have now and the larger number of sukuk could put the secondary market development into a self-reinforcing (positive) cycle of more sukuk leading to more secondary market trading, which would then lead to more issuance.
However, exactly the same logic of a self-reinforcing cycle could start in the GCC with fewer sukuk being issued in the GCC, which would lead the secondary market to become squeezed for new issuance to make up to redeemed or defaulted sukuk. This would see a contraction in the already small trading volumes of sukuk, which would further limit the supply of new sukuk.
Another potential problem this could create for GCC-based issuers of sukuk is that they would have exposure to exchange rate risk. This could be a positive for those issuers with a significant share of revenues and expenses denominated in Ringgit. These issuers would then have debt payable in the same currency as their revenues, which would act as a currency hedge. However, issuers with most of their revenue denominated in USD or UAE dinar or any of the other GCC currencies that are tied to the US dollar would be at risk of having their debt service grow in local currency (USD/AED/SAR) terms if the Malaysian Ringgit appreciates further against the US dollar (and effectively appreciates against GCC currencies).
It may be that the issuers of these sukuk expect the appreciation of the Ringgit against the dollar to reverse, which would lower their debt service in their local currency. However, with underdeveloped mechanisms of hedging against currency risk in a Shari'ah-compliant framework, creating mismatches between the currency where the cashflow is generated and the currency in which debt service payments are made it adds a risk that could hurt the companies that could issue sukuk within the GCC as its sukuk markets develop.
Wednesday, December 08, 2010
Do Sukuk Attract Riskier Borrowers?
After reading the paper "Are Islamic Investment Certificates Special? Evidence on Post-Announcement Performance of Sukuk Issues", I was left with significant questions about what information the study provided. Given the lack of data on sukuk and the limited universe of sukuk issues, it was unlikely to reach a significant conclusion that would illuminate the costs and benefits for sukuk issuers, but the report is a good data point to have, even if I have questions for me about the statistical tests used in the study.
The paper, written by Christophe Godlewski and Laurent Wiell of the EM Strasbourg Business School at the University of Strasbourg and Rima Turk-Aris of Lebanese American University, attempts to determine whether sukuk are beneficial for issuers (and their shareholders). They use a test to determine whether there is a significant impact on the share price of companies (compared to the market) when they announce sukuk versus conventional bonds. The test focuses upon the period plus and minus two days from the issuance. They limit the analysis to Malaysian corporate sukuk because the data (and secondary market activity) in sukuk in other regions is lacking.
The general finding is that conventional bond issuance has no statistically significant impact on a company's share price, while sukuk issuance has a negative impact on a company's share price. The significance is relatively weak (10% significance level), but that is to be expected for the relatively limited data set they are working with.
The authors' conclusion, despite their earlier point that most sukuk are structured to be nearly identical to conventional bonds in economic outcome, is that the profit-sharing structure creates adverse selection problems (companies with worse prospects are more likely to issue a profit-sharing debt instrument than companies with better prospects). They did find that the companies issuing sukuk were generally worse performing than conventional issuers, had higher debt levels and they conclude that the adverse selection problem is the main reason for their results.
With due credit for creating an interesting analysis based on limited data, there are many questions that arise from their analysis. First is why they did not try to account for the performance metrics of the company (based on its underlying fundamentals) to reduce the likelihood that their result of significant adverse market reaction to sukuk issuance was due to the companies fundamentals rather than just the issuance of a sukuk. The specification of their models is not explicitly provided, which makes it difficult to know what control variables they included in the model. For example, they could have used total debt to assets as a way to control for the riskiness of the company (or another metric).
A more fundamental problem is that their conclusion does not fit the actual makeup of the sukuk market. The authors' explanation of the preferability of sukuk over conventional bonds for companies with poor business prospects (or even just more risky prospects) would be justified if sukuk were actually structured as profit-sharing investments (a quasi-debt security). However, this is not how sukuk are structured.
Sukuk are structured (whether they are ijara-based or pre-AAOIFI mudaraba/musharaka or another structure) to replicate the economic outcome of a conventional bond. That means that they are structured so that the company issuing the sukuk is essentially signing up for a periodic payment over several years and then a balloon payment at maturity to redeem the sukuk. The periodic payment is most commonly set based on the prevailing interest rates. From an economic perspective (the perspective of the company's shareholders), the company does not create any different situation whether they use a sukuk or conventional bond.
The interesting test of this hypothesis would be to take the same or a similar data set and re-run the analysis and see whether the outcome is identical with additional control variables included. Specifically, does the finding that companies that issue sukuk have worse stock market performance (and conventional bond issuers have no significant change in performance) remain robust if the specification includes firm-specific control variables to pick up the poorer performance of sukuk issuers? Unless the sukuk involved are structured to actually expose the investors to greater risk than a conventional bond, the reported results will come into question.
The adverse selection problem that is possible with Islamic finance is a serious problem and has led to the industry adopting products that closely replicate conventional debt. However, with the product mix being as it is, it is difficult to argue that there remains an adverse selection problem for Islamic finance and this paper essentially tries to do just that. If the data set allows it, one way to test for the effect would be to try to find whether the effect depends on whether a sukuk is a mudaraba or musharaka versus an ijara (or other debt-based sukuk). The data limitations for sukuk remain difficult within the context of statistical study, but it still leads me to have questions about whether the methodology used in this report is adequate for providing a result that is meaningful for the industry.
The paper, written by Christophe Godlewski and Laurent Wiell of the EM Strasbourg Business School at the University of Strasbourg and Rima Turk-Aris of Lebanese American University, attempts to determine whether sukuk are beneficial for issuers (and their shareholders). They use a test to determine whether there is a significant impact on the share price of companies (compared to the market) when they announce sukuk versus conventional bonds. The test focuses upon the period plus and minus two days from the issuance. They limit the analysis to Malaysian corporate sukuk because the data (and secondary market activity) in sukuk in other regions is lacking.
The general finding is that conventional bond issuance has no statistically significant impact on a company's share price, while sukuk issuance has a negative impact on a company's share price. The significance is relatively weak (10% significance level), but that is to be expected for the relatively limited data set they are working with.
The authors' conclusion, despite their earlier point that most sukuk are structured to be nearly identical to conventional bonds in economic outcome, is that the profit-sharing structure creates adverse selection problems (companies with worse prospects are more likely to issue a profit-sharing debt instrument than companies with better prospects). They did find that the companies issuing sukuk were generally worse performing than conventional issuers, had higher debt levels and they conclude that the adverse selection problem is the main reason for their results.
With due credit for creating an interesting analysis based on limited data, there are many questions that arise from their analysis. First is why they did not try to account for the performance metrics of the company (based on its underlying fundamentals) to reduce the likelihood that their result of significant adverse market reaction to sukuk issuance was due to the companies fundamentals rather than just the issuance of a sukuk. The specification of their models is not explicitly provided, which makes it difficult to know what control variables they included in the model. For example, they could have used total debt to assets as a way to control for the riskiness of the company (or another metric).
A more fundamental problem is that their conclusion does not fit the actual makeup of the sukuk market. The authors' explanation of the preferability of sukuk over conventional bonds for companies with poor business prospects (or even just more risky prospects) would be justified if sukuk were actually structured as profit-sharing investments (a quasi-debt security). However, this is not how sukuk are structured.
Sukuk are structured (whether they are ijara-based or pre-AAOIFI mudaraba/musharaka or another structure) to replicate the economic outcome of a conventional bond. That means that they are structured so that the company issuing the sukuk is essentially signing up for a periodic payment over several years and then a balloon payment at maturity to redeem the sukuk. The periodic payment is most commonly set based on the prevailing interest rates. From an economic perspective (the perspective of the company's shareholders), the company does not create any different situation whether they use a sukuk or conventional bond.
The interesting test of this hypothesis would be to take the same or a similar data set and re-run the analysis and see whether the outcome is identical with additional control variables included. Specifically, does the finding that companies that issue sukuk have worse stock market performance (and conventional bond issuers have no significant change in performance) remain robust if the specification includes firm-specific control variables to pick up the poorer performance of sukuk issuers? Unless the sukuk involved are structured to actually expose the investors to greater risk than a conventional bond, the reported results will come into question.
The adverse selection problem that is possible with Islamic finance is a serious problem and has led to the industry adopting products that closely replicate conventional debt. However, with the product mix being as it is, it is difficult to argue that there remains an adverse selection problem for Islamic finance and this paper essentially tries to do just that. If the data set allows it, one way to test for the effect would be to try to find whether the effect depends on whether a sukuk is a mudaraba or musharaka versus an ijara (or other debt-based sukuk). The data limitations for sukuk remain difficult within the context of statistical study, but it still leads me to have questions about whether the methodology used in this report is adequate for providing a result that is meaningful for the industry.
Sunday, December 05, 2010
Islamic Commercial Paper
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The Banker has a fantastic article on the liquidity management tools currently available to Islamic banks. At the end of the article, it briefly covers an effort by Geert Bossuyt, formerly the head of Islamic finance at Deutsche Bank now with Dar al-Istithmar, to establish an independent Islamic commercial paper (CP) facility for Islamic financial institutions. The article offers few details about the CP plan he is developing, which is based on using a single SPV owned by a charitable trust (to make it independent) using a double-wa'd structure.
The Dar al-Istithmar website provides a little more details, although just in the form of a transaction diagram. From what I can gauge, it is the same structure used by Deutsche Bank for their Al-Mi'yar platform (which I wrote about in a 2009 post).
Source: Dar al-Istithmar.
The structure uses the wa'ad Shari'ah wrapper, which has attracted criticism in the past, although depending on what returns are being swapped, it may not be as controversial as when it was used for generating returns from conventional hedge funds inside of a Shari'ah-compliant wrapper. Here is my best guess on how the product works:
The independent issuer SPV is established and issues its CP certificates to the investors (Islamic financial institutions). The proceeds of these funds are invested in a Shari'ah-compliant asset, whether that is a basket of Shari'ah-compliant stocks, commodity murabaha contracts or any other asset that is Shari'ah-compliant (the diagram says "Shari'a compliant shares", suggesting stocks). The SPV then enters a dual wa'd undertaking with a counterparty to swap the returns of the Shari'ah-compliant asset (presumably) with the returns on conventional money market funds. The dual wa'd would have to be structured to ensure that only one side of the dual wa'd will be exercised (otherwise it would run into Shari'ah-compliance questions).
At this point, the SPV generates a return that is equivalent to a conventional money market fund to pay to the holders of the CP certificates it issued. The counter-party is receiving a stream of returns based on whatever the Shari'ah-compliant assets are invested in, which it can separately hedge using conventional hedging tools (unless it is an Islamic financial institution itself). The investors can hold their CP certificates as long as they have surplus liquidity and if they need liquidity, they can sell the CP on to other investors, who will then receive the stream of money market returns from the SPV.
The risks to the investors and to the SPV is that its swap counterparties are unable to fulfill their side of the swap. If one counterparty became insolvent, the SPV might have difficulty continuing operations because the payments expected by investors would have to be generated by the investments of the SPV. This would likely have a destabilizing impact on the entire platform because it is likely that there would be some general financial market stress, which would lead to lower asset values for the assets held by the SPV. This would probably be accompanied by greater cash needs for the investors in the Shari'ah-compliant CP (and a general desire to hold more safe assets with limited counterparty risk).
If doubts became widespread about the counterparties of the SPV, it could trigger a 'run' on the SPV to redeem shares (if that is possible) or at least pressure on the price of the CP in the secondary market, which would be akin to the problems facing the conventional money market funds that came close to 'breaking the buck' or falling below the $1 net asset value. These problems could be mitigated if not entirely avoided if the counterparties to the platform were one or many central banks of countries viewed to be stable (US or EU for example), although any central bank that had access to the Fed swap lines during the recent crisis would probably suffice (or a multilateral institution like the Islamic Development Bank with a AAA rating and many member countries who could support the bank in its role as the dual wa'd counterparty).
There are always going to be risks that contagion develops for money market products unless they are somehow guaranteed by "reliable" sovereigns. Developing a structure for money market funds will be a tricky business. The current setup of ad hoc bilateral commodity murabaha also creates the same type of counterparty risk, so whether the replacement structure uses a network of commercial counterparties or sovereign counterparties, the success of each product should be viewed on how cost competitive it is to conventional liquidity management tools, as well as how much it reduces counterparty risk over bilateral commodity murabaha. Finally, there will also be an impact of the structure on how widely used it is. The more controversial a structure, the less likely it will be to gain wide acceptance unless it offers something compelling on the other metrics. What is undoubtedly positive is that liquidity management has moved the the fore for new product development. This is probably the best legacy of the financial crisis for Islamic finance.
The Banker has a fantastic article on the liquidity management tools currently available to Islamic banks. At the end of the article, it briefly covers an effort by Geert Bossuyt, formerly the head of Islamic finance at Deutsche Bank now with Dar al-Istithmar, to establish an independent Islamic commercial paper (CP) facility for Islamic financial institutions. The article offers few details about the CP plan he is developing, which is based on using a single SPV owned by a charitable trust (to make it independent) using a double-wa'd structure.
The Dar al-Istithmar website provides a little more details, although just in the form of a transaction diagram. From what I can gauge, it is the same structure used by Deutsche Bank for their Al-Mi'yar platform (which I wrote about in a 2009 post).
Source: Dar al-Istithmar.
The structure uses the wa'ad Shari'ah wrapper, which has attracted criticism in the past, although depending on what returns are being swapped, it may not be as controversial as when it was used for generating returns from conventional hedge funds inside of a Shari'ah-compliant wrapper. Here is my best guess on how the product works:
The independent issuer SPV is established and issues its CP certificates to the investors (Islamic financial institutions). The proceeds of these funds are invested in a Shari'ah-compliant asset, whether that is a basket of Shari'ah-compliant stocks, commodity murabaha contracts or any other asset that is Shari'ah-compliant (the diagram says "Shari'a compliant shares", suggesting stocks). The SPV then enters a dual wa'd undertaking with a counterparty to swap the returns of the Shari'ah-compliant asset (presumably) with the returns on conventional money market funds. The dual wa'd would have to be structured to ensure that only one side of the dual wa'd will be exercised (otherwise it would run into Shari'ah-compliance questions).
At this point, the SPV generates a return that is equivalent to a conventional money market fund to pay to the holders of the CP certificates it issued. The counter-party is receiving a stream of returns based on whatever the Shari'ah-compliant assets are invested in, which it can separately hedge using conventional hedging tools (unless it is an Islamic financial institution itself). The investors can hold their CP certificates as long as they have surplus liquidity and if they need liquidity, they can sell the CP on to other investors, who will then receive the stream of money market returns from the SPV.
The risks to the investors and to the SPV is that its swap counterparties are unable to fulfill their side of the swap. If one counterparty became insolvent, the SPV might have difficulty continuing operations because the payments expected by investors would have to be generated by the investments of the SPV. This would likely have a destabilizing impact on the entire platform because it is likely that there would be some general financial market stress, which would lead to lower asset values for the assets held by the SPV. This would probably be accompanied by greater cash needs for the investors in the Shari'ah-compliant CP (and a general desire to hold more safe assets with limited counterparty risk).
If doubts became widespread about the counterparties of the SPV, it could trigger a 'run' on the SPV to redeem shares (if that is possible) or at least pressure on the price of the CP in the secondary market, which would be akin to the problems facing the conventional money market funds that came close to 'breaking the buck' or falling below the $1 net asset value. These problems could be mitigated if not entirely avoided if the counterparties to the platform were one or many central banks of countries viewed to be stable (US or EU for example), although any central bank that had access to the Fed swap lines during the recent crisis would probably suffice (or a multilateral institution like the Islamic Development Bank with a AAA rating and many member countries who could support the bank in its role as the dual wa'd counterparty).
There are always going to be risks that contagion develops for money market products unless they are somehow guaranteed by "reliable" sovereigns. Developing a structure for money market funds will be a tricky business. The current setup of ad hoc bilateral commodity murabaha also creates the same type of counterparty risk, so whether the replacement structure uses a network of commercial counterparties or sovereign counterparties, the success of each product should be viewed on how cost competitive it is to conventional liquidity management tools, as well as how much it reduces counterparty risk over bilateral commodity murabaha. Finally, there will also be an impact of the structure on how widely used it is. The more controversial a structure, the less likely it will be to gain wide acceptance unless it offers something compelling on the other metrics. What is undoubtedly positive is that liquidity management has moved the the fore for new product development. This is probably the best legacy of the financial crisis for Islamic finance.
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