Where is the Islamic ETF growth?

One of the puzzles of Islamic finance is why Islamic ETFs have not seen a corresponding growth to the rest of the Islamic finance universe.  A Reuters article tackles the subject and suggests that it is the incentive structure in how financial products are distributed in the GCC, the largest market for Islamic finance.  Reuters describes:

In the Gulf, institutional investors are usually catered to by placement agents and fund marketers, not financial planners. These agents, who charge commissions on their sales, prefer to sell private equity, hedge funds and real estate, where margins are higher for them - a hedge fund can charge a 2 percent management fee and a 20 percent performance fee.

That is, the distribution of financial products are run much more along a brokerage model, which is how financial products were overwhelmingly distributed in the the US, and still are to some degree.  However, the rise of investment advisors, who are not reliant on commissions for determining investments, and a general growth in discount brokerages (which has made many investors more cost conscious) has made the relatively cheap, passively managed ETFs more popular.  The investment advisor model is not as prevalent in the Gulf, but Tariq Al Rifai of Dow Jones Indexes says "At some point it will take off...Give it another three years."

However, one of the areas that Reuters only mentions in passing is:

"One attraction of ETFs is that they can provide investors with access to themes that have a low correlation with equities markets. But Islamic ETFs focused on asset classes other than equities have yet to appear, even though major index providers offer large families of sharia-compliant indexes."

Many of the ETFs that provide investors with alternative investors, whether those are hedge funds, individual commodities, and a number of other asset classes (e.g. the VIX index) do not hold the underlying assets themselves, but instead use swaps and other derivatives to gain exposure, either as ETFs or Exchange-Traded Notes which expose the holders to the credit of the issuer and provides return based on the performance of an underlying index. 

The asset classes beyond equities represented by ETFs and ETNs have attracted controversy (ETFs, ETNs) because they are not doing what a normal fund would do--hold a diversified portfolio of investments directly in the fund.   They would also be more difficult to create Islamic versions of, so it is neither clear whether there would be a demand for these products or if they would provide a valuable product for Islamic finance to endeavor. 

In particular, many are leveraged products, and all are designed to be trading vehicles, since they tend to decay in their underlying values regardless of the performance of the underlying indices.  Encouraging extra leverage and frequent trading is likely to not be something that will get favor from Shari'ah scholars approving these products. 

As for plain-vanilla equity ETFs that actually own a portfolio of equities, they may have their day, but it is clearly not upon us yet. 

The role of structured products in Islamic finance

Bloomberg reports that the International Islamic Financial Market (IIFM) is working on a master agreement for derivatives, according to the IIFM CEO Ijlal Ahmed Alvi. The article then goes on to describe Islamic structured products that are having some difficulty meeting international (as opposed to simply local) standards. Structured products combine a debt security with a derivative to provide, for example, returns based on an index performance combined with capital protection. These products are fairly common across the Islamic finance industry and financial institutions like their high fees, while investors may be attracted to the capital protection embodied in them.

However, I think they should be of limited use in the industry because they provide limited benefit to investors (although good returns to the financial institutions offering them in terms of high fees) and are, in my opinion, representative of the worst of financial replication of conventional products in Islamic finance. These products offer the promise of equity-like returns with debt-like risks. The risks of their debt characteristics is understated through claims of "capital protection"; generally these products will only be as safe as the debt offered by the institutions offering these products (or their counterparties in the commodity murabaha products that sit alongside the derivatives that provide the equity returns). It may be that the popularity of these products is due to the lack of debt-like alternatives (e.g. sukuk) for asset managers to diversify across asset classes. Instead of investing in (cheaper) sukuk funds, managers are forced to find quasi-debt investments that also give equity returns.

The reason that I find structured products objectionable is that they hide the risks of debt products with the "capital protection" (I believe they are generally unsecured debt), while generating high fees for the issuer, which can hedge the risks of paying out the upside gains through derivatives. They replicate the most cynical aspects of conventional finance (creating fancy products that generate high fees) with little benefit to investors except providing debt-like protection of capital. In my opinion, the investors would be better off using an equity investment like a mutual fund or managed portfolio of equities balanced with a fixed-income investment through a diversified portfolio of sukuk. However, it is difficult to compose a diversified portfolio of high-grade sukuk. Therefore the appeal of structured products.

Perhaps I am cynical about the rationale for structured products generally in finance. However, they don't seem to serve much purpose except where fixed income markets are lacking. For conservative investors, they would be better suited in lower-fee sukuk funds or deposit accounts at Islamic banks. Non-high net worth investors would be better served by a balance of either Islamic mutual funds or individual equities and sukuk funds. High-net-worth individuals have the resources to invest in diversified portfolios of both equities and sukuk (in addition to some alternative assets). Hiring managers within each asset class is surely a lower cost method of investing than structured products. This even omits the role that Islamic ETFs (if they were prevalent) could serve for investors just wanting to track the benchmarks with some diversification.

The IIFM has done some good work standardizing commodity murabaha contracts (the Master Agreement for Treasury Placements) and with the planned master agreement for asset-backed sukuk. Even the derivatives master agreement (Tahawwut) which has attracted criticism is valuable because Islamic banks, like other conventional financial institutions, need to hedge against currency and interest rate fluctuations (and other companies need to hedge commodity price fluctuations). However, tailoring standardized documents designed for structured products is not going to provide much benefit to the industry as a whole. It may lower costs, but that is unlikely to lower costs to issuers, but these probably will not pass through to investors who are charged high fees in conventional structured products as well.

As much as the sukuk structures are criticized for replicating conventional bonds, they at least serve a primary purpose in most, if not all, portfolios as fixed income replacement. The same cannot be said for structured products, which I suspect are favored by financial institutions for their high fees with little regard for whether they add much to the end client's portfolio.

IMF report, UAE Islamic banks, tawarruq attracts criticism, effects of the Dubai World debt agreement

The IMF released a study in August 2010 that provided an interesting analysis of what drove growth in Islamic banking from 1992 to 2006. The main finding of the study was that oil prices (which created a significant inflow of liquidity into the GCC, which is a major region for Islamic banking) had the largest effect. One interesting specification they used included both the price of oil and a dummy variable to measure the effect of 9/11 (to see whether growth was higher after 9/11, all other things being equal) and found that it did on its own, but when the effects of the oil price were included, the impact of 9/11 became insignificant. This suggests that the rise in oil prices in the 2000s was much more impactful on the growth of Islamic banking than 9/11. The argument for the impact of 9/11 was that following the attacks, many funds that were invested in the West were repatriated to (mostly) the GCC.

The head of Shari'ah at the Islamic Development Bank, Sheikh Mohammed Mukhtar Al Salami, says that tawarruq is 'usury' and therefore is 'haram'. His argument is that the transaction is "being carried out by Islamic banks as mere concealed usury operations as they are done not only at one place but at two place", reiterating an argument made by the Fiqh Council of the OIC. The OIC Fiqh Council's argument differentiated between classical tawarruq and organized tawarruq. In a tawarruq transaction a bank sells a metal of a client with deferred repayment (cost-plus-profit) and then the client sells the metal to get cash. In an organized tawarruq (also called reverse murabaha), the bank facilitates the sale of the the metal in the spot market (although the metal brokers used on each side of the transaction are different). Tawarruq is a commonly used product by Islamic financial institutions and greater Shari'ah risk around the product highlights the need for short-term liquidity management tools for institutions and new products for consumers, as tawarruq attracts more criticism.

Several articles describe the effect of the Dubai World debt agreement on other sukuk. Bloomberg reports that it is unlikely to lead to a 'massive' rally according to the CEO of Mashreq Capital in Dubai. Another Bloomberg article notes that the Dubai World agreement has failed to benefit Tamweel sukuk. Tamweel is a troubled Islamic mortgage company in Dubai that may be merged with Amlak Finance, another Islamic mortgage company, with assistance from the Dubai government. The Dubai World agreement could move the spotlight onto Nakheel, which has paid its trade creditors in cash and sukuk and has also repaid 2 of its 3 sukuk with assistance from the Dubai Financial Stability Fund. The Dubai World deal does raise an issue with Nakheel: the first two sukuk were repaid at par whereas Dubai World creditors accepted a writedown of principal and an extended maturity. The next key date for Nakheel is January 16, 2011 when the Nakheel Development 2 sukuk (the final one) is scheduled to mature. Will investors be forced to take a haircut or will the DFSF step in again to ensure repayment at par? It is too early to tell.

Profits in UAE-based Islamic banks fell 17% in the first half of 2010 compared with the same period in 2009. This is somewhat expected as the impacts of the financial crisis hit this region slightly later than in other parts of the world. However, despite the fall in profits, analysts believe the banks have not provisioned enough for non-performing loans, particularly in real estate in construction, the two sectors hit hardest.

Takaful continues to grow, but it is several years behind the growth in Islamic finance. Prudential BSN Takaful, a joint venture between Prudential PLC and Bank Simpanan Nasional Bhd in Malaysia, is launching three new takaful plans. An African Reinsurance company African Re, is launching a retakaful subsidiary with a wide focus on Africa, the Middle East and Asia. The Bahraini takaful compay t'azur recently announced a retakaful agreement with Hannover Re, a large conventional reinsurance company. Retakfaul is the Shari'ah-compliant version of reinsurance and has been very limited in availability. The Sri Lankan takaful firm Amana Takaful says that its operations are hampered by a lack of enough Shari'ah-compliant investments. If the takaful plan were managed like a conventional insurance pool, it would invest most of its assets into sukuk. However, the sukuk market has not been large enough to support the needs of takaful companies as well as other Islamic investors and unless there is significant growth in sukuk, takaful companies will have difficulties. They could invest in other assets: real estate, equities, commodities. However, all of these are more volatile than fixed income and it will probably not end well if a significant proportion of takaful fund assets were invested in these asset classes if there were a repeat of the financial crisis or even a less severe recession. It also makes it more difficult for the managers of the takaful funds to project its long term assets and ensure they match with expectations about its long term liabilities.

Other News

• The Javelin JETS Dow Jones Islamic International Index Fund, the first US-based Islamic ETF, will close. The company cites limited investor interest "through the marketing channels typically used by ETFs" according to Javelin's president Brint Firth.
  
• Mapletree Industrial Trust, a Shari'ah-compliant REIT, is raising $800 million in an IPO in Singapore.
  
• Indonesia plans to issue sukuk and global bonds in the first half of 2011. The government reduced its sukuk issuance in 2010 when deficits came in lower than expected. Several of the sukuk auctions failed during 2010 because investors demanded a higher yield than conventional bonds to account for the lower liquidity of sukuk compared to bonds.
  
• The development of Islamic banking in India is still not possible and the Indian Centre for Islamic Finance has approached the Reseve Bank of India, the central bank, and asked it to allow a few banks in Mumbai to open Islamic windows on a pilot basis before it considers any regulatory changes.
  

Malaysia as a primary legal jurisdiction for Islamic finance, Islamic finance news

Malaysia wants to become a hub as the country where Islamic financial contracts are governed. Currently, most Islamic finance contracts are governed by English laws, because of its predictability. While Malaysia has a unique position having a Shari'ah advisory council at its central bank and could therefore provide governmental legitimacy to the process of litigating whether certain contracts were or were not Shari'ah-compliant, it would likely run into difficulty because the country's Shafi'i interpretation of Shari'ah is viewed as more liberal than the Hanafi and Hambali interpretations used in the GCC. Therefore, it may be unlikely that an Islamic finance institution would submit to the jurisdiction where a different interpretation of Shari'ah is prevalent.

The Shari'ah Advisory Council of Bank Negara Malaysia gave the go-ahead for wa'd (unilateral promise) to be used to hedge against currency fluctuations as long as there is no compensation paid for the wa'd, which would make it a bilateral wa'd. The promise is binding on the promisor.

Rusdhi Siddiqui's latest article tackles the area of Islamic finance news, which I agree does have too little depth behind it. Bloomberg articles (not to pick on them alone) give the bullet points and then re-spout market statistics with too little context. Other news outlets just string together a few quotes with generalities about "Islamic finance is designed to avoid interest, etc". If this blog does anything, I hope it provides a current and critical look at the Islamic finance industry. It certainly has an inherent bias towards the Islamic finance industry, but I have also been critical of the "party line" talking point (for a while at least) that Islamic finance was not harmed by the credit crisis. And thankfully, there are other reporters out there who take stands against things that are either ridiculous Panglossian ideas or products that too cynically avoid the restrictions that are the heart of the Islamic finance industry. However, it is always a good time to remind oneself to think critically.

Other News

• Kiplinger has an interview with Monem Salam and Nicholas Kaiser of the Amana Funds.
  
• Details about the Dubai World restructuring are coming and I expect more to come out as the process of implementing the restructuring proceeds.
  
• Mushtak Parker wrote an article about the growth of Islamic ETFs.
  
• Pakistan's government plans to sell sukuk by the end of the month. The sukuk are expected to carry a maturity of less than on year.
  
• Despite many suggestions that Islamic finance could become viable in Russia, there are few Islamic financial institutions in the country.
  

Shari'ah scholar licensing, IIT sukuk, Islamic indices

Bloomberg has a more detailed article about the planned Shari'ah scholar certification body, although the details are not yet fully described. I think this is a positive development because it will provide a way for newer or less recognized scholars to build credibility and become selected to be members of Shari'ah boards. This will increase the number of qualified scholars with experience that could be the biggest development to get around the well publicized lack of scholars that are selected to serve on Shari'ah boards. Currently, most Islamic financial institutions select the most recognizable Shari'ah scholars to gain credibility about the Shari'ah-compliance of their offerings. This has led to the top scholars being on many, many Shari'ah boards, which limits the amount of time they can devote to each. This could lead to less thorough review of each product than if the workload were spread across a larger number of scholars. Hopefully the ISRA proposal will move beyond the planning stage and on to become an organization that carries as much weight and recognition as AAOIFI or the IFSB.

There is an article in The Banker about Islamic indices, which have only been around since 1999 when Dow Jones launched their Islamic Finance World index. The article is interesting and notable because it mentions the absence of ETFs (not total absence; there are a few, but not many and most are very small). The Islamic funds industry has grown significantly in the past 10 years, so it seems that the ETF sector would be a natural area for growth as an alternative to actively-managed mutual funds.

The small sukuk ($10 million) from the International Innovative Technologies, which is the first UK-based company to issue a sukuk, is being heralded as the first of many from the UK and Europe. However, I think it is unlikely that this small sukuk, which was subscribed by one entity, Millenium Private Equity, will have that effect. The sukuk--a sukuk al-musharaka--came obout when an investor in IIT suggested Islamic finance as a way to finance the business. This (along its small size and status as a 'first') reminds me of the East Cameron sukuk, which was issued by the US-based wildcatter oil & gas firm with properties offshore Louisiana. While I am not predicting that the sukuk will end up the same way the East Cameron sukuk did (with the bankruptcy of the issuer), I do think that the idea that a small sukuk from a relatively unknown issuer can spark further issuance is overstated. It will take a larger, more well-known issuer to demonstrate that sukuk are the "real thing" to other potential issuers in the UK and Europe. That may happen in the near-term, but it will not make IIT the one that broke the market open. However, it is a start--albeit a small one--that will generate plenty of media attention that could make a sukuk from a better known issuer less surprising. It will be interesting to see what happens from here.

The secretary-general of AAOIFI, Dr. Mohamad Nedal Alchaar, has an opinion article in The National about the potential for France to develop its Islamic finance industry.

Other News

• The current issue of Opalesque's Islamic Finance Intelligence has several interesting articles. One by Shahzad Siddiqui and Toby Birch discusses gold bullion and Islamic private equity. Mohammed Khnifer discusses what happens when sukuk default.  Nikan Firoozye discusses the structure of the consecutive or rolled murabaha. The full issue can be downloaded by clicking through to any of the articles.
  
• South Korea may revive the bill to put sukuk on par with conventional bonds, after it was scuttled earlier this year.
  
• According to an IMF report, the driving force behind the growth in the industry after 2000 was the rise in oil prices, not 9/11. I hope to post something on the report when I have a chance to read it.
  
• The Thai Securities & Exchange Commission will issue rules for sukuk in October, according to the body's Secretary-General.
  
• Kuwait Finance House-Turkey may issue $100 million more in five-year sukuk, after its first issue in August, which was also the first sukuk issued in Turkey. The government of Turkey may consider issuing sukuk "in the future" according to the Finance Minister Mehmet Simsek.
  
• The Central Bank of Bahrain's Sukuk al-Salam was oversubscribed with BD73.5 million ($195 million) in subscriptions for the BD12 million ($31.5 million) issue. The return on the three month securities will be 0.69%.
  
• DIFC Investments will make a scheduled $2.88 million periodic payment on its $1.25 billion sukuk on time, according to a statement posted on NASDAQ Dubai.
  
• A paper in South Africa discusses the basics of Islamic banking.
  
• Malaysia issued four takaful licenses, primarily to foreign companies as it liberalizes its financial sector in a bid to attract more Islamic finance.
  
• Islamic finance could exceed $2 trillion in the next three-to-five years.
  

Dubai World, Saad Group

The Dubai World debt negotiations hit another potential snag with the repayment of the Nakheel sukuk maturing in May becoming more likely even without a restructuring deal. This compounds the issues caused by the offer of a 1% interest rate for banks who are owed money by Dubai World at the same time that trade creditors are offered 40% cash payment with the remaining 60% paid through a sukuk yielding 10%. A top official at Al Ghurair, which is described as a 'key trade creditor' by Emirates Business 24/7, said the 10% profit was "very generous".

I have previously questioned whether the restructuring would incorporate Shari'ah-complaince and there still has not been a complete reporting of this aspect of the restructuring. However, the use of a sukuk to repay trade creditors indicates that Dubai World remains interested in Islamic finance. The big potential problem is the differential treatment of different creditors, most of which are unsecured creditors. Banks are offered 1%, trade creditors offered 10% on a portion with the remaining being repaid while sukuk holders of the sukuk maturing next month receive full repayment. This differential treatment does no favors to Islamic finance because it reinforces the uncertainty about the rights of creditors in one of the largest geographical concentrations of sukuk issuers. This will make it more difficult for issuers to bring new sukuk to market because although the problems are largely Dubai-related, the uncertainty is generalized to the UAE, if not the GCC. Although the debt holders would suffer delays and would probably come out worse for it, for the Islamic finance industry, it may have been preferable for the whole Dubai World mess to end up in the tribunal in front of internationally recognized judges under DIFC law, which closely resembles English law.

Sukuk holders of the Saad Group have agreed to dissolve the sukuk trust. According to a Reuters factbox, the Saad Group sukuk was an asset-based sukuk, which would mean that the dissolution of the sukuk trust does not provide investors with an avenue to recover their money except through a bankruptcy proceeding as unsecured creditors of Saad Group, where they would be treated equally (pari passu) with other unsecured debt holders and subordinated to any secured creditors.

Khalil Jarrar has an interesting column in the latest Opalesque Islamic Finance Intelligence.

My latest article on the East Cameron sukuk was published by Islamic Business & Finance in the latest issue.

Other News

• The World Bank and the International Finance Corporation will be in Malaysia to discuss a Shari'ah-compliant fund for green technology investments.
  
• The relative strengths and weaknesses of using equity vs. debt in Islamic finance acording to an executive at Elaf Bank in Bahrain.
  
• Arcapita is planning to build a fund management business to reduce the cyclicality of revenues in the private equity business. I believe this is something that more Islamic investment banks and private equity houses will undertake to smooth their revenues and reduce the prospects of being severely harmed in future downturns and this is good for the industry as a whole.
  
• The Abu Dhabi Stock Exchange may begin to indicate which investments are Shari'ah-compliant and which are not.
  
• The CEO of a Malaysian invesmtent bank, Alliance Investment Bank, says that sukuk have a promising future.
  
• Kencana Petroleum Bhd, a Malaysian oil and gas services company, is planning to issue $78 million (MYR250 million) in sukuk sales. Cagamas issued $156 million (MYR500 million) in 5 year sukuk that were rated AAA by MARC because Cagamas is state-owned.
  
• Indonesia issued $22 million in sukuk, about 20% of its planned offering. Demand was limited, according to reports, because of limited liquidity in the sukuk.
  
• KPMG in India has expressed support for the development of guidance from the central bank for Islamic financial institutions in the country which have been slow to develop.
  
• The latest monthly commentary abou the performance of the Dow Jones Islamic Market Indexes for April is now available.
  
• Dundee University in Scotland will offer a postgraduate degree in Islamic finance.
  
• AsiaOne has a summary of Islamic finance structures that are commonly used.
  
• The company offering Salaam Halal, Principle Insurance Holdings, has been sold to a Kuwaiti buyer who was one of the largest shareholders.
  
• AAOIFI will hold its annual meeting at the end of May.
  
• The new Christian ETFs will not be a competition to Islamic financial products, but will encourage greater uptake of ethical products, according to an article in the Malaysian Insider.
  

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

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

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

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

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

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

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

Other News

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

Nakheel sukuk, Khazanah exchangeable sukuk in 2010, US Islamic mutual fund and ETF launching

Nakheel's $3.52 billion sukuk traded at 107, its highest value since doubts emerged about the ability of Nakheel and Dubai World, which guarantees the sukuk, to repay. The rising price indicates that there is greater certainty that Dubai will ensure the sukuk is redeemed at maturity. The redemption value includes principal plus deferred lease payments, so the redemption value is greater than par. A blog post at The National notes that the sukuk is an unsecured obligation of the company, something that is clear in the prospectus but which had been questioned following the reported transfer of properties from Nakheel to Istithmar.

Khazanah Nasional plans more exchangeable, USD-denominated sukuk next year to reduce its stake in several of its holdings. Khazanah issued an exchangeable sukuk a couple years ago backed by shares of Telekom Malaysia. The sukuk was structured where the common shares were the assets on which the sukuk was based and the profits paid to investors were covered by the dividends paid on the common shares. The investors in the sukuk were able to later exchange their sukuk into shares of Telekom Malaysia.

The United States Islamic investment market is getting a lot deeper as Saturna Capital launched its Amana Developing World Fund and ShariahShares ETF should be launched in Q1 of 2010, managed by California-based Florentez Investment Management. The new Amana Fund will be invested in developed country-based companies with significant revenue from international operations. The ShariahShares ETF will likely include two passively-managed funds, one based on the FTSE Yasaar Shari'ah U.S. Index and the other on FTSE Yasaar Shari'ah Developed World ex-U.S.

In another sign that the sukuk market is still very undeveloped for longer maturity sukuk, even from sovereign issues, the Indonesian regular sukuk will likely have less than 15 years maturity. The Finance Ministry director in charge of Islamic markets told Reuters that "The maturity of the sukuk will likely be shorter [than 15 years because] the sukuk market is still not yet developed".

Other News

• There is a good summary of the French legal changes to accommodate Islamic finance in the country, specifically the changes relating to murabaha and sukuk.
  
• A few sovereign sukuk issues will come next year including Indonesia, Pakistan and South Korea. Not to mention the potential for the U.K., Singapore, Hong Kong and the Japan Bank of International Cooperation, which could also come next year.
  
• An American firm developed a 'longevity-linked investment platform'.
  
• Rushdi Siddiqui, the global head of Islamic finance for ThomsonReuters, recreated the Palm Jumeirah in his garden.
  
• A new Islamic investment firm, Fajr Capital, launched with shareholders including Malaysian Khazanah Nasional, Brunei Investment Agency and the Abu Dhabi Investment Council.
  
• The CEO of Unicorn Investment Bank discusses the investment bank's growth.
  
• Daimler Financial will offer Shari'ah-compliant financing in the UAE.
  
• The Kerala government in India will finance infrastructure projects and other investment opportunities through a Shari'ah-compliant investment company.
  
• Syria is seeing growth in takaful.
  
• The merger between Amlak and Tamweel, two troubled Islamic mortgage firms will 'take time' according to UAE central bank governor Sultan Nasser al-Suweidi.
  
• Bahrain Financial Exchange launched two product development working groups, one devoted to developing Shari'ah-compliant products.
  
• The Managing Director for the MENA region for Boeing says there will be growth in Islamic finance including in aircraft finance.
  
• The Qatar Investment Authority and Malaysian Khazanah Nasional Bhd are working to set up a joint investment fund.
  

Investment Dar, zakat fund, SRI and Islamic finance, IBB sees wider loss, France not ready for Islamic banks

The Investment Dar is making progress with its creditors having reached a Standstill Agreement, which will postpone the claims by its creditors as part of its restructuring plan. There is not yet final resolution of the $100 million sukuk which the Investment Dar defaulted on, but the Standstill Agreement is a step on the way to a possible resolution.

A zakat fund managed by BMB Islamic is nearing launch. However, the fund has generated some controversy from Shari'ah scholars who argue that zakat is meant to be distributed to the needy and not invested.

A publication bringing together the contributions of 19 lawyers will explain the legal and Shari'ah aspects of Islamic finance will be published by Chancellor Publications. It was edited by Humayon Dar and Umar Moghul.

The BBC has an article on Islamic finance, one which describes the growth of Islamic finance, particularly in the U.K. following 9/11 when investing in the U.S. became more difficult and was perceived as having additional riskiness.

There is an interesting article from Gulf News about the differences between ethical investing and Islamic investing. While there are similarities in many of the screens used by Islamic and socially responsible investment funds, there are differences that may make some Shari'ah-compliant investments not pass other ethical screens, primarily those around environmental issues because Islamic indices have an overweighting in energy companies which often are not the most green.

Dr. Abbas Mirakhor warns that Islamic finance can face systemic failure and reputation risks because it is not well enough regulated internationally and in some countries. He was speaking at the Malaysian Securities Commission and said that the Malaysian system had the most advanced regulatory system for Islamic financial industry that could serve as a model. He also spoke about the potential for a food and commodity crisis. At an Islamic Financial Services Board seminar, Dr. Zeti Akhtar Aziz, the Bank Negara Malaysia governor said that the Islamic financial industry has been resilient and continues to grow and innovate with new products. However, there remain gaps in the legal framework, Shari'ah standardization and and Islamic financial products face different risks from conventional products. A prominent scholar Mohamed Akram Laldin says that Shari'ah scholars should be held accountable for "clear mistakes in their decisions".

The Islamic Bank of Britain saw its loss widen as the economic conditions and the low benchmark interest rates hurt the profitability of their increased deposits. The bank says it may need to scale back its growth unless it raises additional capital in order to continue its compliance with prudential capital requirements.

The head of France's central bank, Christian Noyer, says that the country is not yet ready to issue an Islamic banking license yet because of concerns over safety and soundness. The French Central Bank, which does not control monetary policy following the foundation of the European Central Bank, has been approached by several institutions looking to establish Islamic banks in the country, but does not yet have the same level of knowledge and familiarity with Islamic banking as the U.K. regulator, the Financial Services Authority.

The lising of sukuk from Petronas and Cagamas could signal the continuing growth in the sukuk markets following the credit crisis. In the wake of the credit crisis as the effects spread globally throughout the financial markets and economies, the issue of new sukuk nearly completely dried up compared to 2007 when a record amount of sukuk were issued.

Other News

• Jamelah Kamaluddin becomes the first woman to head an Islamic bank with her appointment last year as the managing director of RHB Islamic Bank.
  
• South Korea is offering tax incentives to promote the use of sukuk and has changed regulations to ensure that the profits for sukuk holders receives the same tax exemptions as interest payments on conventional bonds.
  
• Kuwait Energy received a $50 million murabaha financing from the World Bank Group's International Finance Corporation.
  
• An article discusses Islamic ETFs, including the recently launched, U.S.-based Javelin ETF, which has not turned interest in it yet into significant trading volume. The ETF market in the U.S. will be broadened with the launch of 2 new funds from ShariahShares, managed by California-based Florentz Investment Management.
  
• Bloomberg will focus on Islamic finance in its expansion in the GCC.
  
• The Muslim Community Cooperative Australia launched another fund, an Income Fund, following its launch of a Mortgage Income Fund.
  
• Bank Negara Malaysia, the Malaysian central bank, has signed an agreement with the Hong Kong Monetary Authority to cooperate on financial issues particularly Islamic finance.
  
• The National Bank of Kuwait launched its third Kuwaiti Dinar-denominated Ijara Fund.
  
• Malaysian firm Sime Darby will issue RM4.5 billion ($1.3 billion) in medium-term Shari'ah-compliant notes
  
• The report I wrote for Yasaar Media is briefly described in a press release available from AMEinfo.
  
• Ernst & Young is organizing a conference on Islamic finance in the Channel Islands. Islamic retail banking executives and Shari'ah scholars will meet for a conference in Dubai on October 12 to discuss the future of the industry.
  

Islamic ETF in the U.S., sukuk data from 2009Q2

One of the areas of Islamic finance in the United States that has remained relatively stagnant in terms of developing new products and the entrance of new companies is Islamic investing. However, with the launch of the first Islamic ETF in the US, this is changing. The new ETF is the Dow Jones Islamic Market International Index Fund and it is based on the Dow Jones Islamic Market Titans 100 Index composed of 100 large international Shari'ah-compliant equities. The new ETF was launched by Javelin Investment Management. The index will be rebalanced annually except for corporate actions like delistings and mergers which will be adjusted as needed.

Despite a recent surge of sukuk issues in the GCC, the pricing of these sukuk remain elevated compared with the pricing from a year or two ago. The latest reminder is the Saudi Electricity Corporation sukuk which was priced at SAIBOR+160bps compared with SAIBOR+45bps for their first sukuk in 2007. The increase could be due to a combination of factors including recent defaults as well as the impact of the credit crisis which reduced risk appetite and a fall in the oil price since its highs of $147 per barrel last year which has reduced capital inflows into the GCC.

The sukuk market for new issuance in the second quarter is 35% below the same period last year, but a pickup in activity of 164% in the second quarter compared to the first quarter as well as a healthy pipeline indicates that recovery may be in sight, according to Zawya.

Other News

• First Community Bank, an Islamic bank in Kenya, launched an investment banking subsidiary, FCB Capital, the first of its kind in the country.
  
• Mawarid Finance, an Islamic financial company in the UAE, signed an agreement to cooperate with the Dubai government in promoting small and mid-sized enterprises (SMEs) and hopes to sign similar agreements in the other Emirates.
  
• A law passed in the Malaysian parliament would make rulings by the Shari'ah Advisory Council binding on courts when the courts refer disputes to the Council. A member of parliament complained during debates that the Islamic financial industry is too focused on profits and rates in line with conventional financial industry interest rates are too high.
  
• Growth of the HSBC Amanah brand in the UAE suggests a lot of demand for Shari'ah-compliant financial services, according to Frank Kane writing in The National.
  
• The six major Pakistani Islamic Banks are close to launching an Islamic interbank market to avoid relying on conventional short-term financing.
  
• Islamic finance is finding a nexus between Shari'ah-compliant investments and a focus on sustainability with recent investments in the water industry and agriculture.
  
• Sukuk holders of the Golden Belt 1 sukuk were unable to reach a decision on whether to dissolve the sukuk and receive a payout. The sukuk was issued by the troubled Saad Group.
  
• At a time when some sukuk issuers are under pressure to meet their obligations, Kingdom Installment Company is redeeming the full value of their ijara sukuk that financed 5,000 home purcahses and was launched in 2006.
  

The Economist on GCC sukuk, first Canadian Shari'ah-compliant ETF planned

Canadian Islamic finance compaany UM Financial is partnering with Jovian Capital Corporation to explore the launch of a Shari'ah-compliant ETF. North America currently has a lack of investment products for Muslim investors. Although there are a few mutual funds, the landscape is currently dominated by Amana Funds which offers only two Islamic mutual funds. The greater development of Shari'ah-compliant ETFs would serve to expand the investment options available to Shari'ah-sensitive investors.

The Economist discusses the prospects for the Gulf bond and sukuk markets following the credit crisis and the first GCC-based sukuk default (The Investment Dar).

In a report for LSE's Kuwait Proramme on Development, Governance and Globalization in the Gulf States, Rodney Wilson points out the "the search for alternative means that Islamic banks are likely to receive more attention" in the wake of the credit crisis that originated in conventional financial institutions in the US.

Other News

• The Islamic Development Bank may raise its planned sukuk issuance from $5 billion over 5 years to $6 billion over the same period.
  
• NCB Capital commented on the prospects for GCC sukuk issuance, while Malaysian-based Aminvestment provided a rosy outlook for the Malaysian sukuk market.
  
• Islamic banks are levying 'maintenance fees on small accounts and are treating them as current accounts and not providing them with the profit-sharing features common for accounts at many Islamic banks.
  
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• Standard & Poor's has launched an Shari'ah-compliant version of the S&P/TSX 60 Index.
  
• The Investment Dar continues the process of restructuring, forming a steering committee to communicate with investors.
  
• Salama, a takaful and re-takaful company has partnered with Credit Agricole Asset Management to launch a series of Islamic funds.
  
• An article describes the methods by which trusts can be created to be Shari'ah-compliant.
  
• Malaysia's Securities Commission revised its list of Shari'ah-compliant securities to add 13 and remove 1. Unlike most other countries, Malaysia centralizes many Shari'ah-compliance functions.
  
• Terry Lacey describes the ASEAN annual meeting of Shari'ah scholars held in Indonesia and warns the industry of 'flying to close to the sun'.
  
• Hawkamah issued a declaration calling for the development of isolvency and creditor rights systems for the Middle East and North Africa "Noting the importance of Islamic finance institutions in the region and beyond".
  

BNI to issue sukuk in Malaysia; Turkey's sukuk "should not be belittled"

PT Bank Negara Indonesia (BNI), the third largest state-owned bank in Indonesia, may issue up to $50 million in sukuk in Malaysia. The issue will depend upon market conditions for sukuk in Malaysia. Many new sukuk issues are likely to depend heavily on the market conditions during 2009. Estimates of sukuk are $4-5 billion for 2009 for Malaysia and Southeast Asia, but I would not be surprised if there were as few as $3 billion (if conditions stay the same or worsten) or as much as $8-$10 billion (if there is a significant recovery in global credit markets, particularly if the price of oil leads to a resumption of funds into the GCC region.

I don't know whether this was in response to my blog post yesterday where I said Turkey's first sukuk 'was a flop' (kidding, my blog isn't that widely read), but the head of Turkey's Capital Market Board said "The demand for the revenue-indexed bonds should not be belittled. For a start, it's a good figure". In part, this is true because the bonds are the first from Turkey, are not explicitly called 'sukuk' and are being launched in a time of unprecedented credit constraint.

Indian-based Benchmark Asset Managment will launch India's first Shari'ah-compliant exchange traded fund (ETF), a passive fund tracking the S&P Nifty Shari'ah Index, an index that tracks 37 Indian stocks accounting for nearly ½ of the market capitalization of the National Stock Exchange.

Shari'ah screens have in the past eliminated many companies that have subsequently went bankrupt amid fraud. One prominent examples are Enron and Worldcom, which were excluded from Shari'ah screened investment portfolios more than a year before it collapsed because it exceeded the allowable debt ratio. I looked at the press release at the inception of the S&P Nifty Shari'ah Index on February 18, 2008 and it included among its largest ten companies Satyam Computer Services. As far as I can tell, it was still included in the index at the time its founder revealed a massive fraud. Although Shari'ah screens can provide additional safety, this demonstrates that they are not always completely effective.

Doha Bank still planning renewable energy sukuk, the future of Shari'ah-compliant ETFs

Doha Bank still plans to issue a $1 billion sukuk to finance a GCC carbon trading market and other renewable energy investments like solar, although it continues to be delayed by turmoil in the global credit markets.

IndexUniverse.com discusses the potential for Shari'ah-compliant ETFs and compares the performance of the underlying MSCI World and MSCI World Islamic, as well as comparing the sector allocations of the two indices. There are ETFs tracking other indices and I think that the results would come out similar: Shari'ah-screened indices performed better than unscreened indices since the beginning of 2007; Shari'ah screens lead to overweighting in energy, materials and healthcare and underweighing in financials. The article goes on to discuss the future of Shari'ah-compliant which appears bright but still a little ways in the distance.

An article on what Mauritius needs to do to develop a more prominent place in the Islamic financial industry also includes a good description of the development of Islamic finance in Africa. Another article, focusing on the Islamic finance industry in Kenya, has a short discussion on Shari'ah-compliant securitization.

The U.K. paper the Times describes the growth in Islamic finance in Britain both among Muslims and non-Muslims.

Exchange Traded Commodity (ETC) funds, IFQ, Arcapita, Tamweel and CBB Sukuk Al Salam

Some of the first Shari'ah-compliant Exchange Traded Commodity (ETC) were launched by ETF Securities with ETCs for Gold, Silver, Palladium, Platinum Silver and Precious Metal Basket. They are trading on five exchanges in Europe.

The Islamic Finance Qualification from the Securities & Investment Institute will soon be available in Singapore through Praesidium PTE.

Shari'ah-compliant investment firm Arcapita reported higher profits in fiscal 2008 nearly twice the profits in 2007.

Tamweel, a Shari'ah-compliant mortgage lender in the UAE, Egypt and Saudi Arabia sold $300 million of sukuk to finance the expansion outside of the UAE. The 87th issue of the Central Bank of Bahrain short-term 90-day sukuk was oversubscribed by many times, a common occurrence for some of the few short-term sukuk available. The Sukuk Al Salam sukuk issues have been 6 million Bahraini Dinar (about $17 million), just sufficient to replace maturing sukuk according to the Central Bank of Bahrain (pdf, page 10).

Sukuk, ETFs, Shari'ah scholars, Islamic finance interfaith efforts

Six years after Malaysia became the first country to issue a sovereign sukuk, the Malaysian news agency Bernama describes how much the industry has developed since then. One of the primary indications of this development is the rush of non-Muslim financial centers like London and Hong Kong. Arab News also has a summary of the growth in Islamic finance, specifically the rapidly growing demand for sukuk.

The Indonesian Sharia Banks Association (Asbisindo) says there needs to be a more concerted effort to promote Islamic banking in the country. Despite being home to the largest Muslim population, neighboring Malaysia has a much more well developed Islamic finance sector. The Islamic Corporation for the Development of the Private Sector, an organization affiliated with the Islamic Development Bank has plans to invest in the Islamic financial sector in Indonesia.

Qatar plans to develop a secondary market for sukuk and Shari'ah-compliant ETFs on the Doha market. Malaysia recently launched an Islamic ETF.

The shortage of Shari'ah scholars is once again in the spotlight, this time in an article in Forbes magazine.

Devon Bank in Chicago, Illinois recently received an award for a Shari'ah-compliant financing of a purchase of property by an Islamic Foundation from a Lutheran church, which played a significant role in the spirit of inter-faith cooperation.

Weekly news update, December 15, 2007

The U.K. faces a significant challenge from Dubai, Bahrain and Kuala Lumpur to become the sukuk capital of the world. However, the U.K. is looked to as the model for developing Shari'ah-compliant banking from other countries in Europe, like France and Germany, where the Muslim population make up a larger percentage than in the U.K. I discussed this in one of the articles in the recent Institute of Halal Investing newsletter, available in pdf (there is also a link along the right side of the blog).

The ETF issuing company iShares announced the issuance of three Shari'ah-compliant ETFs. The three ETFs track the MSCI World Islamic, MSCI Emerging Markets Islamic and MSCI U.S. Islamic indexes.

GCC-based Islamic investment banks are expanding outside of the GCC-area, as Gulf Finance House's projects in India and Tunisia demonstrate.

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I have not been able to blog daily the last couple weeks. I hope to be able to more often next year, but for the rest of the month, the weekly updates may be all I have time for.
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Islamic finance critique, sukuk and ETFs

The Washington Post has an article describing a few critiques of Islamic finance.

Financial Times' Lex column notes the lack of use of Islamic finance in some countries like Indonesia, although sukuk now represents 76 percent of all bonds issued in Malaysia.

Japan's second-biggest securities firm, Daiwa, will list a Shari'ah-compliant exchange traded fund on the Singapore exchange which tracks Shari'ah-compliant Japanese equities.

Shari'ah-compliant ETFs, DIFX sukuk

Malaysia's government committee on exchange traded funds (ETFs) recommended the development of Shari'ah-compliant ETFs.

The Dubai International Financial Exchange (DIFX) saw its sukuk listings increase from $7.63 billion to $12.78 billion, a growth of 40 percent.

"This industry doesn't need more players, what it needs is size. The need is to create mega banks,"--Salman Younis, Kuwait Finance House (Malaysia) Bhd Managing Director

New takaful products, LLB announces first Islamic ETF

CIMB takaful expects RM1 billion ($290 million) after it rolled out three new products.

Liechtensteinische Landesbank (Switzerland) Ltd. (LLB) launched the first Islamic Exchange Traded Funds (ETF), which are linked to the performance of the LLB Hilal Indices. "The LLB Hilal Indices provide a transparent benchmark for Shariah-compliant investors who wish to gain exposure to the "Islamic Crescent Region (or "Islamic Hilal"), a moon-shaped geographic area spanning from Morocco to Indonesia, including Turkey and Pakistan."

Dar al Istithmar lost it's Islamic economist and six or seven other staff members to BMB Group.

CSR, Indonesia and the GCC

A summit on corporate social responsibility (CSR)opens today in Dubai. The summit will focus on the lead provided by Western businesses as well as Islamic finance:

"The business case for CSR in the Middle East region is gaining momentum. Islamic finance is setting a good example and in many ways runs in parallel with socially responsible investing. Stakeholders now want to be associated with businesses that support a whole range of social or environmental benefits, which is still a challenge for regional corporate cultures to absorb."

Asia Times Online has a detailed description of the present and future of Islamic finance in Indonesia.

Dar Al Istithmar, a subsidiary of Deutsche Bank, has been absorbed by BMB Group to create BMB Islamic. Very little informationis available about BMB Group. Its holding company is an offshore company in Brunei.

The growth of the Islamic financial industry in the GCC has led to increased calls for the development of short-term Shari'ah-compliant financial products which companies can use for liquidity management. One way some firms do this is by wakala (e.g. Amlak Finance's $800 million, 360-day wakala), where investors give "cash with a lender who then uses it to buy qualifying financial assets. The investor gets a commission and a share of the profits generated by the funds."

Rushdi Siddiqui, global director of the Dow Jones Islamic Market Indexes, is in Malaysia discussing the necessary underpinnings of an Islamic exchange traded fund (ETF).

The Investment Dar and Airbus are considering a joint venture to provide Shari'ah-compliant financing for aircraft purchases.

Srei Infrastructure Finance Ltd. becomes the first Indian company to receive approval from the Reserve Bank of India to use Islamic financing over Rs. 200 crore (Rs. 2 billion; US$49 million). "[Sunil] Kanoria [Srei's director] was reluctant to share the details of the instrument, but said that the the cost of financing would be lower than any similar instrument in India. Industry sources said it might be similar to a quasi-equity bond."

"'Moving forward, TAQA will attempt to balance its Islamic and conventional borrowing,'," says Peter Barker Homek at an Islamic project finance conference. Islamic financing could capture GCC project finance market.