Limiting property market speculation without disadvantaging Islamic banks

Now that the Dubai property market bubble and bust is largely in the rear view mirror, there have been institutional changes to limit the prospects of a bubble from reoccurring.  These include banks increasing their review process, increased government regulation of the share of assets any bank can have exposure to and also a thus-far mooted effort to limit the maximum loan-to-value limits for real estate. 

In a recent interview, Faisal Aqil, deputy CEO of Emirates Islamic Bank said bluntly that a short-term profit tax was required in order to curb excessive speculation in the property markets.  This isn’t the first such call to use taxes to quell speculation in markets, but his position in an Islamic banks raises the question of why there hasn’t been more of a call from Islamic bankers to limit speculative activity in property markets, because they are supposed to avoid financing speculative investments like short-term ‘flipping’ of property. 

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Dubai courts void ijara agreement for property that was not completed on schedule

A Dubai court voided an ijara agreement on the basis that it represented not a lease, but a sale contract and the asset being sold was not completed when the developer started collecting payments.  Prior to the Dubai real estate crash, many investors signed agreements that forced them to pay rent upon the anticipated completion date of their property.  However, when the debt crisis hit and projects were mothballed, developers charged rent for uncompleted units.  The court’s ruling—although it does not create precedent—follows criticism by Dubai’s Grand Mufti in 2011 and should lead to changes in ijara contracts used in sales of new residential units.  

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The Eurobond market as a template for Dubai

After the financial crisis, sukuk issuance has reached new high levels, and many of the issuers are GCC-based.  However, secondary market liquidity has not matured as quickly.  The Eurobond market development from the 1960s to the 1980s provides an instructive case study that can be used to facilitate greater secondary market trading.  If the same liquidity (relative to primary issuance) in sukuk is achieved, the size of the market for dealers facilitating the trade is significant.  Secondary market volume could represent almost ten times the level of primary market issuance.  With total sukuk issuance in 2012 reaching $131 billion globally, with about one-quarter from GCC issuers, this represents a potential GCC secondary market of roughly $325 billion, which could generate revenue for dealers of perhaps $2 - $3 billion.  It will take work to reach this, but it should be a very attractive market for dealers.

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UK government faces uphill struggle to be Islamic finance hub

The UK government established an Islamic Finance Task Force to try again to find its place as an “Islamic finance hub” which it never fully attained before the financial crisis.  The government’s decision not to pursue a sovereign sukuk as recently as 2011 set London back in its ambition to challenge financial centers in the Middle East and Southeast Asia for preeminence.  The stated reason for not issuing the sovereign sukuk was that it did not ‘provide value for money’, which if true strictly on the basis of cost  could turn out to be a shortsighted mistake.  

The London Stock Exchange remains a formidable challenger for any exchange seeking sukuk listings, but the rest of the UK Islamic finance industry is underwhelming at best.  The opportunity cost from not issuing a sovereign sukuk after so many years of market expectation could be a significant headwind that an Islamic Finance Task Force will struggle to overcome.  If the UK hopes to attract capital through sukuk as a result of the task force—something it has struggled with to date—it will need to build credibility that the UK government is not just opportunistically looking to Islamic finance and that may be the hardest thing to do with the shelving of the sovereign sukuk.

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