Islamic wealth management, avoiding future crises, Moody's says Islamic finance could reach $5 trillion

The Islamic wealth management report from Bank Sarasin raises one point which I believe is true across the Islamic finance industry: the diversification of assets is not nearly as expansive as in conventional finance and in many cases leaves investors with too much exposure to real estate. It also is too focused on transaction-based compensation for Islamic bankers. The emphasis is placed on deals and there is too little focus (and compensation based on) the long term needs of Muslim investors. As an asset manager myself, I have watched the Islamic finance industry expand, particularly in the issuance of sukuk, with much of the focus on new financial products that expand the financial structures used in conventional finance. That is not necessarily problematic because good diversification relies on different asset classes from which investors can choose. However, when the focus is on creating a diverse set of structures and not on the types of investments, there will be an unmet need. For example, the equity asset class has been the easy part with Islamic indexes being around for over 10 years now. However, there remains a shortage of fixed income-like products that is only partially filled by sukuk (for example, there is still no fixed income-substitute within the United States). A lot of the other structures being created have still focused on property finance. There can be many different ways created to provide investors with exposure to real estate markets, but that still only addresses one asset class. It may create diversification (e.g. geographical) within that asset class, but a focus on real estate markets as a predominant investment area leaves asset managers struggling to create a diversified portfolio for Muslim clients (whether or not they are exclusively focused on Muslim clients). Perhaps the (nearly) global property bust will will make other areas more attractive, but it may just create a new area where activity is concentrated. That would be a shame and would harm the investors that are the source for the Islamic finance business.

The CEO of Fajr Capital, Iqbal Khan, said that Malaysia can provide an example for reform within the Islamic finance industry, particularly to separate the utilitarian and financial intermediation roles to prevent the problems that arose during the credit crisis. Mr. Khan said that there should be a separation to prevent the need in a future crisis for Islamic investment banks to be bailed out the government to preserve the basic payment systems within the banking system. Those payment systems could then be backstopped if necessary but ""Everything else - Mudharabah-based, asset-based, unit trust and investment fund - goes into separate business. These two, never the twain shall meet, they have to be kept separate". I believe he is absolutely correct. The flaw with the universal banking model and allowing the investment banks and commercial banks to merge (in the U.S., this was through the Gramm-Leach-Bliley Act) forced the government to bail out all or none of the banks and the combination of the two into large financial holding companies meant that in order to keep the payment systems intact, the investment banks had to be bailed out lest their losses endanger the institutions as a whole, which led to the crisis within the 'boring' areas of the credit markets unrelated to the investment banks' operations.

Moody's says that Islamic finance assets could grow to $5 trillion without providing a date by which this could be reached. They said assets were $950 billion in 2009, which is higher than previous estimates from other groups which were in the range of $800-$850 billion. Moody's says that Shari'ah-compliant derivatives, if 'employed with care', could provide a useful purpose for hedging purposes. The recent IIFM master agreement on Islamic derivatives includes a requirement that they only be used for hedging, not speculation. Moody's VP and Senior Credit Officer Anwar Hassoune cautioned that "IFIs aim to utilize derivative instruments to hedge against risk and to improve risk monitoring practices. However they are keen to do so in a Sharia-compliant manner, rather than imitating conventional derivative instruments, in order to avoid losing their special status as Sharia-compliant banks, which makes them very attractive to a large population of Muslims." Moody's warns that IFIs have weak asset-liability, investment, and liquidity risk management. An article published by the Wharton School at the University of Pennsylvania discusses the role of ratings agencies within the Islamic finance industry, specifically within the sukuk market.

Other News

• An article in the Financial Post (Canada) discusses the recent UFANA conference in Toronto (at which I was a speaker).
  
• $4.67 billion in sukuk were issued in the first quarter of 2010 according to Zawya, compared with $0.63 billion in the same period in 2009. Malaysian issuers accounted for 53% of all new issues, Indonesia for 33.5% and Saudi Arabia with 9.6% from the Dar Al Arkan sukuk of $450 million. Malaysia is planning a US dollar-denominated sukuk.
  
• An opinion column in the Kuwait Times asks whether Islamic banking has enough focus on providing a competitive and quality product to ordinary people.
  
• A GCC-based VP at iShares offers an interesting view of the current state of Islamic indices.
  
• Just as private equity has faced significant headwinds over the past 2 years, so has the Islamic private equity industry and things are just starting to get back to doing deals.
  
• The New York City Bar is planning a seminar on Islamic law including a portion of the seminar covering Islamic finance.
  
• Indonesia's efforts to expand the share of its banking system made up by Islamic banks is described in an article from the Oxford Business Group. The government is planning a 5 trillion rupiah sukuk (555 million) issue on April 13.
  
• Standard Chartered's Islamic finance window has avoided Islamic hedge funds based on a concern that the arbun structure used to create short-selling-equivalent has not been widely accepted among Shari'ah scholars.
  
• An article describes what AAOIFI does and what it is working on now.
  
• Sudan, which has been largely cut off from capital markets since US economic sanctions were imposed in 2007 because of the genocide in Darfur, is issuing $300 million in sukuk.
  

Dubai World, Islamic hedge funds

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

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

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

Other News

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

Islamic finance restructuring news

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

Other News

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

Dubai may issue more bonds to support government related entities, Kuwait government may bail out TID

Dubai has handed out nearly half of its first tranche raised in its recent $10 billion to government related entities including DP World and Nakheel. The government of Dubai is also likely to issue another $10 billion tranche of bonds to continue to support GREs including assistance to Nakheel as its $3.52 billion sukuk reaches maturity in December (a sukuk I discussed earlier this month). Troubled Islamic mortgage providers Amlak and Tamweel will not be merged until after they are restructure, plans for which are expected in a "few weeks" according to Sheikh Khalid Bin Zayed Bin Saqer Al Nahyan.

The Kuwaiti government may bail out troubled Islamic investment bank The Investment Dar which recently defaulted on its sukuk, the first such default in the GCC. Critics point to a mismatch between cash flow and liabilities as well as the company's highly leveraged position which included its partial takeover in a leveraged buy-out of Aston Martin. Two interesting paragraphs in the article, which touches on systemic risk in Islamic finance, the topic of my forthcoming opinion piece in Business Islamica magazine:

"Bankers agree that the TID default may be a one-off and would not have a contagion effect even if there were one or two more defaults in the Sukuk or wider Islamic finance market. The financial market generally also prices in default probabilities to a certain extent.

"Another Islamic capital markets expert, however, warned that the main "issue has always been a lack of transparency in the structure and Shariah compliance process. The issuance is also not under a well-regulated jurisdiction familiar with Islamic financial products. Obviously there will be some contagion, as investors will now relook at the structure of the product they are holding. But it is fortunate that there is no secondary market otherwise the mark to market valuations across the board would be in a state of disarray."

Other News

• The Saudi Gazette has an article summarizing the speech given by Enad Al-Menaie, the chairman and managing director of the Liquidity Management House at the 6th IFSB Summit in Singapore recently.
  
• Brunei issued the 30th in its series of short-term ijara sukuk. So far the country has issued over B$1.6 billion ($1.1 billion) in ijara sukuk since April 2006. One of the topics discussed at the AAOIFI conference was the use of arbitration instead of commercial, secular courts in handling disputes about Islamic financial products.
  
• AAOIFI held its annual Shari'ah Conference in Bahrain on May 18-19, 2009. Indonesia will host a meeting of Shari'ah scholars from Southeast Asia later in May.
  
• Indonesia may issue another sukuk, this one for IDR 5 trillion ($485 million), later this year.
  
• UM Financial Group, a Canadian Islamic finance company, and Mint Technology are launching prepaid cards targeting the Muslim community in the country.
  
• An interview with Eric Meyer, CEO of Shari'ah Capital describes their strong balance sheet and the performance of their long-short equity funds which focus on commodities.
  
• The managing director of Korea Investment & Securities Co. Ltd. discusses the country's interest in Islamic finance in an interview.
  
• Bank Islam and MayBank Islamic have both denied reports that they may merge.
  

Islamic finance liquidity, hedge funds and virtual banking

• Many Islamic finance practitioners believe that hedge funds are 'unsuitable' for Islamic finance because the costs would make them uncompetitive compared with conventional hedge funds. There is also significant disagreement about the Shari'ah-compliance of many products used in hedge funds such as leverage, swaps and derivatives. The head of Malaysia's Securities Commission, the country's capital markets regulator, believes that hedge funds could help add to market liquidity and they would "assess and consider whether they meet licensing criteria" if an application were submitted.
  
• Islamic banks are hurting their resilience and ability to manage liquidity, market and credit risk by relying too heavily on debt-based products like murabaha because they cannot be securitized to meet liquidity needs of banks according to an article in Asharq Alaswat. The article cites the role of Fannie Mae and Freddie Mac in the United States as a model of how securitization can help banks expand and increase the liquidity of their assets.
  
• Although only four of Yemen's 18 banks are Islamic banks, they have been gaining market share according to the Central Bank of Yemen and now account for 31 percent of the total assets held by banks in the country. The growth rate of 22 percent in Islamic banks' assets represent 40 percent of the total growth during 2008, a greater than proportional increase.
  
• Indonesia's growing deficits are providing a source of supply of sukuk that could increase the country's involvement in the Islamic finance industry. The country just sold $650 million in its first dollar-denominated sukuk and the issue was seven times oversubscribed. The five-year ijara sukuk was sold to a geographically diverse set of investors including 30% from the GCC, 19% from the US and 11% from Europe. The junk-rated (BB-) issue offering a return of 8.8% is rated on par with other external debt issued by the country by Standard & Poor's.
  
• Neil Miller, a lawyer with Norton Rose, says that Islamic firms in the GCC are eyeing acquisitions in the West in the wake of the credit crisis and economic recession and could act in the second or third quarters of 2009. He cautioned that the merger process within a Shari'ah-compliant framework is still not well developed.
  
• With many investment banks reducing headcount there is a growing pool of experienced bankers looking to enter the Islamic finance industry. The managing director of Global Islamic Banking at Calyon Simon Eedle says that this means "the days of a shortage of Islamic bankers and the outrageous compensation that some were being paid are finished". However, Hidayathullah Baig, the head of Islamic finance at Islamic bank, the First Energy Bank, warns that "there is a danger of these conventional investment bankers trying to impose their ideas onto Islamic structures" that he believes is "very dangerous".
  
• Malaysia is continuing to increase the centralization of the country's Islamic finance industry under proposed legislation that would force civil courts to look to Shari'ah advisory board at either the Central Bank, Bank Negara, or the capital markets regulator. The move which comes following several contentious cases looking at the Shari'ah-compliance of the bai bithaman ajil (BBA) contract. BBA is a form of financing similar to murbaha but it is viewed as non-Shari'ah-compliant outside of Malaysia because of its similarities with conventional interest-bearing loans. Judges currently have discretion about whether to seek the advise of the national Shari'ah advisory boards.
  
• Islamic banks in the GCC could expand into the West by setting up virtual banks or an online Islamic bank in the UK, Canada or the US according to Mohammed Badi, Principal at the Boston Consulting Group.
  
• While there is not universal consensus among Shari'ah scholars of the compliance of several products including BBA and bai al inah, the products in common use are converging towards similar forms. Some of the controversial products like BBA are being phased out in order to attract more clients.
  
• The uncertain regulatory environment around Islamic finance, particularly relating to Shari'ah-compliance could hamper the industry's growth. In addition, the economic crisis has led to a near halt in the issuance of sukuk during 2008 and the first quarter of 2009 and, although there is a significant amount of sukuk in the pipeline, if liquidity is not restored to the industry, "there is a real threat to the business of Islamic banking" and "we may not be able to continue doing our business" according to the CEO of Dar al-Shari'ah, Sohail Zubairi. A recovery in the global economy, however, could help the industry recover, as could mergers between institutions.
  

Mid-week update

• Malaysia will sell MYR3 billion (about $1 billion) in 30-year Islamic savings bonds this year.
  
• The BBC has a piece on the growth in Islamic finance.
  
• The wealthiest Muslims did not embrace Islamic finance, but in the wake of the credit crisis, Islamic wealth managers think they could shift their assets towards Shari'ah-compliant investments to reduce their risk exposure and protect their assets.
  
• Amiri Capital is launching their Islamic hedge fund-of-funds. The launch was delayed when Lehman Brothers, the original partner in the effort, went bust.
  
• The merger of Amlak and Tamweel, the two troubled Dubai Islamic mortgage companies, could be completed this summer. A decision on the structure of the merger is expected "soon".
  
• Seven people were charged in a fraud that involved receiving financing for fictional projects and companies from Dubai Islamic Bank and alleged kickbacks. Dubai Islamic Bank issued a statement on the investig.
  

Sukuk issuance falls 66% in 2008, lowest since 2005

The issuance of new sukuk fell to $15.77 billion in 2008 compared with $46.65 in 2007 according to data collected by the Islamic Finance Information Service (IFIS), a drop of 66.2% year-over-year. The last time issuance was lower than the 2008 total was 2005 when $10.76 of sukuk were issued. The global credit crisis and difficult economic conditions were blamed for the fall which demonstrate that, although Islamic finance does not have exposure to the direct causes of the crisis (subprime-backed mortgages and derivatives), it is affected by the health of the conventional credit market and global economic conditions.

Cerulli Associates estimates that Shari'ah-compliant funds have $65 billion in assets under management and are expected to grow at an annualized 12% rate. The article describes this total as "a figure that’s more modest than the hundreds of billions of dollars often cited by regulators and industry players". Although there is fair criticism to the $300-$500 billion number often cited as the size of the Islamic finance industry (reliable statistics are largely unavailable), the $65 billion in the fund management industry should not be compared with the "hundreds of billions of dollars". Usually the $300-$500 billion figure is cited to account for the entire size of the Islamic finance industry worldwide which includes assets management, retail banking, sukuk and the other areas of Islamic finance like private equity.

The Dubai Shariah Hedge Fund Index was launched containing four Shari'ah-compliant hedge funds using Shariah Capital's long/short trading platform, most of which focus on commodities. Because conventional short selling is not Shari'ah-compliant because of prohibitions of selling things one does not own, the hedge fund platform has raised some criticism that the idea of an 'Islamic hedge fund' is not possible nor desirable.

The growth rate of the Islamic finance industry is expected to exceed the general economic growth rate in Malaysia. The second finance minister of Malaysia Nor Mohamed Yakcop believes the Anglo-Saxon capitalist system has failed and "If the Islamic banking system had made an impact earlier, then it may have been possible to avoid the economic disorder as the system will not bring such problems". I believe this is further expression of naivete that the Islamic financial system will not be accompanied by any of the problems of its conventional counterpart such as greed.

A real estate company in the UK used Islamic finance to refinance the debt on its property holdings in London.

Indonesia will issue a sovereign sukuk aimed at retail investors in February.

One of the conventional banks in Kuwait, the Global Investment House, has defaulted on its debt. Global Investment House along with Islamic bank The Investment Dar announced that they needed up to $1 billion in loans from the government. The Investment Dar has been reported to be selling assets including part of its stake in Aston Martin which it acquired in a Shari'ah-compliant LBO in 2007.

Islamic hedge funds, short selling, derivatives, standardization.

Amiri Capital, a Malaysian firm, plans on launching its Shari'ah-compliant hedge fund early in 2009. The delay was delayed from this year when the prime broker they had been working with, Lehman Brothers, went out of business in September. The hedge fund's structure of its mechanism for shorting stocks (which, as conventially practiced, is haram because it amounts to selling something that you do not own). Two contracts, arbun and salam, are mentioned as possibilities. Using arbun, the purchaser provides the seller with a deposit towards the purchase of a good at a future date. If the purchase is not made, the seller keeps the deposit. Salam contracts establish a sale at a given price with delivery on a future date.

The Securities Commission in Malaysia is also deciding whether to allow Islamic financial institutions to short a limited number of stocks in order to "boost market liquidity" and that this has been approved by the SC's Shari'ah board.

The Malaysian central bank, Bank Negara, plans to issue guidelines for Islamic financial institutions to create greater standardization and establish a international Shari'ah research academy, a helpful development at odds with sentiments of members of the AAOIFI Shari'ah board.

The International Swaps and Derivatives Association (ISDA) and the International Islamic Finance Market (IIFM) are working on a standardized master agreement for Shari'ah-compliant derivatives for hedging (Ta'Hawwut).

The governor of the Central Bank of Bahrain, Rasheed Al Maraj, says that the credit crisis has been little impact on the Islamic financial institutions so far but, "The effects of the global financial crisis on the real economy have the potential to transmit shocks to Sharia-compliant institutions as well. This means that there must be a very high priority placed on sound management and risk management practices at Islamic financial institutions".

Fox News, a conservative news organization jumps on the anti-Islamic finance bandwagon in a story full of hyperbole, misinformation and fear-mongering with Frank Gaffney even saying that Islamic finance is a "seditious system that supports jihad". I typically don't like to even give space on my blog to criticisms that have so little basis in fact, but when they emerge from the fringe network of think tanks that create their own little echo chamber into a news organization that has mass appeal (in the U.S. at least), it should be mentioned for what it is.

One positive point in the article was a few quotes from Islamic finance practitioners who were quoted refuting the specious allegations thrown around:

"Nicholas Kaiser, fund manager at Amana Mutual Funds Trust in Bellingham, Wash., said that his company's Shariah-compliant mutual fund products are no different from any other religious funds and that the company carefully screens its investors. 'Our shareholders are American. We don't take money from non-Americans because of money-laundering laws. We have to know our shareholders and be sure they aren't engaged in nefarious activities. We screen and check and verify every shareholder,' Kaiser said. 'We simply take people's money, invest it and give it back to them when they want it. We don't try and convert the country. We don't have any religious position. We aren't evangelical. We aren't zealots. We're money managers,' Kaiser said. 'I happen to be Episcopalian.'"

Ibrahim Warde, a professor at Tufts University, is quoted explaining the motivations of the extreme critics of Islamic finance: ""People who don't like Islam and who are afraid of Islam would obviously not like the notion of Islamic finance. I'm not sure that those who hold this view necessarily know much about it, but it's some kind of visceral view that some people hold"

Islamic finance at risk from fall in prices in the real estate market; CGAP study on Islamic microfinance released

My fears that the credit crisis in conventional financial markets is spilling over to Islamic finance are becoming to be realized. The primary mechanism I identified in my blog (and in greater detail in a forthcoming opinion piece for Business Islamica magazine) for transmitting a crisis through the Islamic banks was falling property prices in the GCC countries that had mostly escaped the direct fallout from the subprime crisis that began in the United States. Although the prices have not fallen as dramatically as in Western countries, they are beginning to fall and this has an effect on Islamic banking because these assets are the underlying physical property used in many Islamic financing deals. From a Gulf Daily News article: "Falling prices in mainly Muslim countries in the Middle East and Southeast Asia are likely to affect the Islamic finance market due to heavy reliance on such assets to support deals." A senior analyst at Zawya, Alexandra Tohme, adds her opinion on the link between Islamic financial institutions and the global credit crisis.

The Dinar Standard has an interesting article about the potential for Islamic banking in Europe.

The Financial Times has a Q&A on the basics of Islamic finance, as do a number of newspapers in the U.S. and there is also an article on finance based in Christianity.

Islamic finance could still grow by 20-25% a year despite the financial crisis according to Rushdi Siddiqui, the Global Director of the Dow Jones Islamic Market Indexes, but "Islamic banks should diversify their investments to generate revenues from different areas."

Hedge fund managers are targeting Muslim investors in the Middle East by developing Shari'ah-compliant hedge funds, but is it too late for them to attract investors given their often poor returns during the past couple of years.

The DIFC has lent its support to the new Master Agreements for Treasury Placements (MATP), the standardized contract from the International Islamic Finance Market (IIFM) that was recently announced.

Zurich Financial Services Group has launched a joint venture takaful company with the Abu Dhabi National Takaful Company to expand their operations in the GCC region.

The Consultative Group to Assist the Poor (CGAP), a multi-lateral effort to promote microfinance and based at the World Bank, released a study of 125 Islamic microfinancial institutions.

Shari'ah risk, the credit crunch, falls in sukuk issuance

Another article discussing the controversy surrounding the ruling by AAOIFI on the repurchase agreements contained in many sukuk also brings up another as yet unexperienced risk: default. Until now, the focus was on 'Shari'ah risk' of which the AAOIFI ruling was the most striking example. It essentially ruled that a common form of ijara sukuk containing the repurchase of the underlying asset at par which was approved by Shari'ah boards was no longer Shari'ah-compliant.

Different people within the Islamic finance industry have different views on whether the Islamic finance industry has been and can be moving towards standardization. I believe some degree of standardization is necessary, for no other reason than it would help address the shortage of Shari'ah scholars for the time being until there is a less dire shortage of scholars. Khalid Howladar, a senior credit officer at Moody's, believes that Shari'ah-compliance will not necessary become standardized, nor should it, since the most important factor for Shari'ah-compliance is not form, but the intention behind the transaction.

The credit crunch has had a significant impact on the Islamic finance industry and represents part of the cause of the fall in sukuk issuance. Other products, like Amiri Capital's "Shariah fund of hedge funds", are delayed. Amiri's launch is delayed because their prime broker, Lehman Brothers, is now bankrupt and mostly sold off to Barclay's and Nomura.

A Shari'ah scholar, Mohammad Akram Laldin, raised the prospect of new controversy about Shari'ah-compliance by criticizing products that merely mimic conventional finance products. Speaking to Reuters, he remarked, "People tend to, to a certain extent, dilute some of the principles or objectives of certain contracts in order to accommodate conventional features".

The Islamic Bank of Britain released its first half 2008 financial results showing a smaller loss than during the current period caused by the launch of several products.

The G8 countries continue to race towards being the first to issue a sovereign sukuk.

Dubai Group, a conglomerate of companies, wants the Dubai International Financial Centre (DIFC) to become a center of Islamic finance.

The Central Bank of Bahrain sukuk al-ijara was oversubscribed by 120%.

Hong Kong wants to attract Islamic finance; Can hedge funds be Shari'ah complaint?

The CEO of Hong Kong's Securities & Futures Commission, Martin Wheatley, continued the drive to attract Shari'ah-compliant finance to the city-state in a speech today (the speech is available as a pdf). In the speech, Mr. Wheatley noted that the Hong Kong exchange presents a way for investors to "capture the investment opportunities in an emerging market [China], while enjoying the services and investor protection of a developed market". Mainland Chinese firms account for only 19% of the total listings on the Hong Kong exchange, but for 57% of total market capitalization and 70% of total volume. There are already tracking funds for the Dow Jones Islamic Market Hong Kong/China Titans Index as well as a large Malaysian sukuk (one of the Khazanah exchangeable sukuk) and the prospect for a sovereign sukuk from the Airport Authority.

U.K.-based think tank Chatham House released a survey about the GCC's development as a global financial center, including a brief discussion of the Islamic finance industry there. The report (available as a PDF) notes that "the subjective element can also create long delays and uncertainty [so a] number of Islamic investors are not fully tapped into or committed to this market [because they are] unsure what products really are Sharia-compliant". However, "broadly speaking, Sharia scholars are now in agreement on product design and the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is taking some steps in the direction of harmonization. This should help create greater trust and clarity among ordinary potential clients, generate more demand and help the industry to expand more widely."

CPI Financial has commentary by Bill Gibbon, a lawyer at Voison, and Trevor Norman of Volaw Trust & Corporate Services, on the Shari'ah-compliance of hedge funds and ways in which some funds have adapted some Islamic finance products to replicate short sales and margin. What is not covered is whether a hedge fund, which they define as ‘a fund that uses derivatives, leverage, shorting, margin trading and option techniques to achieve its absolute return investment goals’ is in its whole, Shari'ah-compliant. Instead, they focus on the component transactions that run into problems with Shari'ah scholars.

Islamic finance in the GCC has a concentration of government ownership larger than would generally be predicted, according to a recent Moody's report on Islamic finance.

Qatar Islamic Bank plans to launch its own takaful provider. A number of takaful companies are sprouting up around the GCC following the success of Islamic finance in the region.

The first publicly-listed Shari'ah-compliant REIT will soon be available in Singapore. The REIT will be converted from a conventional REIT with a large stake in the management company being taken by the National Bank of Australia. The debt currently owed by the REIT, the Cambridge Industrial Trust, will be converted in Shari'ah-compliant financing.

Islamic finance in the West: Can it survive and thrive?

Emirates 24/7 has an open article about whether Islamic finance will succeed in the West. There are some factors that indicate high potential for Islamic finance to succeed, while other factors that could limit the industry's growth in the West. On the positive side, Islamic finance has many similarities with socially responsible investing. The socially responsible industry in the West has grown rapidly and there are now over $1 trillion in assets under management that go through at least one ethical screen. Because Islamic finance shares many of the socially responsible screens, there is great potential to use the same techniques used by Islamic finance to broaden socially responsible investing to other areas of finance. On the negative side, the Muslim population in the West is relatively small compared with other areas like Malaysia and the GCC, so there is a limited base of consumers who would be willing to use Islamic financial products, even if they are more expensive initially. There are also some significant legal, regulatory and tax changes required to put Islamic finance on a level playing field with conventional finance that may not necessarily be made. On balance, positive regulatory support reported by some within Islamic finance and the strong interest in ethically-based finance support the potential for Islamic finance, in my opinion.

Dr. Malik Muhammad Al-Awan, director at Furqan Research, belives Islamic banking in Malaysia should focus on developing innovative new products to support and accelerate its growth. The growth in Islamic finance should continue because of high commodity prices creates greater liquidity in and demand for Islamic finance products.

Takaful premiums have grown rapidly in the last year, although its size and development continues to lag the Islamic finance industry as a whole. Last year, total takaful premiums were $2 billion and are expected it increase to $7 billion in 2015, an annual growth rate of 17% per year. The total assets of takaful providers in Malaysia are $2.5 billion, 6.8% of the total assets of the insurance and takaful industry in the country. Globally, there are now over 120 takaful providers. Many of these providers are investing assets in sukuk, potentially contributing to the excess supply (and buy-and-hold mentality) which has contributed to slowness in the secondary market for sukuk .

Euromoney has an article on opinions of fund managers about offering Shari'ah-compliant versions of their funds to attract institutional and high-net worth money from the GCC region. FinanceAsia.com has an article about how Islamic finance is finding ways to replicate more complex financial structures in sukuk.

Thailand sovereign sukuk, GCC financial centers and Islamic hedge funds

Thailand could issue its first sovereign sukuk in 2008.

The Economist has a description of the growth of the GCC region financial centers in Bahrain, UAE and Qatar.

Shari'ah Capital, a New Canaan, Connecticut-based firm is working with Barclay's to offer the first Islamic hedge fund. The fund uses Shari'ah-compliant alternatives to options and short selling and will allow investors to choose from several different hedge fund managers and investment strategies.

Offshoring beneficial or detrimental to Islamic finance image in the West?

Barclay's, with the assistance of Shariah Capital, is launching Islamic hedge funds, which provide investors with exposure to "six or seven long-short hedge funds". Given the Shari'ah problems likely to arise from investing in hedge funds which take short positions, it is not surprising that Barclay's has an aversion to transparency similar to much of the hedge fund industry. The rationale by which the product is deemed Shari'ah-compliant is proprietary.

Does offshoring of Islamic banking make sense? A Reuters article about the drive by the Cayman Islands to capture some of the Islamic finance market addresses the additional scrutiny Islamic finance receives in the U.S.:

"Islamic finance still struggles outside the Middle East against the perception, widespread since the Sept. 11 attacks on the United States, that it is tainted by terrorist funds. [..] 'Sharia law or no sharia law, all funds have to be regulated by the same anti-money laundering and anti-terrorism laws as traditional funds,' said Rod Palmer, a managing partner of Walkers in Dubai."

While the additional scrutiny given to Islamic finance is probably unneccessary (based more on misconceptions and misunderstandings), it might be easier to clear these misunderstandings up if the industry was concentrated in on-shore financial centers. It would also provide a larger constituency to lobby governments to introduce financial regulations that do not discriminate against Islamic finance, as has already occured in the U.K. around home financing, banking, and sukuk.

The head of Malaysian Affin Islamic Bank says that Malaysian banks should expand regionally to meet the demands throughout Asia for Islamic banking.

Hong Kong wants in on the Islamic bond market

The growth of Shari'ah-compliant banking has greatly increased the demand for unique banking software for Islamic banks. Most Islamic banks are either using modified conventional banking software, although a few have probably taken the expensive dive into custom-made Islamic banking software. Perhaps the growth of Islamic banking-specific software could reduce the trend of just 'Islamizing' conventional financial products.

Bahrain Islamic Bank established a separate real estate company called Abaad Real Estate. With the recent property price collapse in the U.S. due to massive overbuilding and under-regulated finance companies, I can't help but start to worry about when a similar thing occurs in the GCC region, where new real estate finance companies spring up with suprising frequency.

Islamic hedge funds, Malaysia & newspaper supplements in China

An interesting take on the possibility of Islamic hedge funds. One issue though is to determine whether hedge funds attaching the 'Islamic' label are "using markets wisely" and not "speculate, play passing the parcel as long as it's someone else" and deal with the fact that many of the interpretations used by many of the Malaysian firms are not accepted widely outside of Malaysia.

Malaysia is "losing a lot of experts in Islamic banking and finance" to other countries, says PM Badawi

Malaysia will cease to issue Islamic banking licenses to foreign investors. New foreign entrants will need to partner with local firms.

Indian Banks Association waiting on Reserve Bank of India to decide on the "regulatory framework for introducing sharia- compliant products"

A supplement in today's China Post promoting Malaysia as a center of Islamic finance.

UK sukuk conference & controversy about Islamic hedge funds

There will be a conference in London, UK from June 20-21, "The Sukuk Summit - Strategies for Today: Demystifying Islamic Capital Markets (ICM) Products". The details and links to the summit website and press release are available from the IHI conferences listing for June 2007

Islamic hedge funds are controversial. One speaker on the topic at a conference in Bahrain told conference participants "he had nothing to say because [Islamic hedge funds] do not exist" due to the prohibition of 'selling what you don't own'. Others argue that the basic hedging strategies are Islamic in intent by providing risk control.

The Dana Gas convertible sukuk announced yesterday is part of a growing wave of convertible bond issues in the Gulf Cooperation Council (GCC) driven by the recent poor performance of the regon's equity markets.

Middle Eastern investors, likely from Kuwait or Qatar, will finance a Shari'ah-compliant real estate investment project in Japan.

Prudential, the U.K. insurance company, signed a Memorandum of Understanding yesterday with Saudi bank Aljazira to take a 39 percent stake in the bank's takaful business, Ta'awuni, as well as part of the bank's fund management business.

"ETFs could track the benchmark index, or certain growth sectors, or even Islamic finance. " --The Star (Malaysia)

Slipped through the cracks

I missed an article last Wednesday on FT.com about Islamic investing. The article is particularly interesting because it tackles headon the issue of whether Shari'ah-compliant products are viewed as Islamic by most Muslims. With the advent of Islamic credit cards and hedge funds, the differences between Islamic and conventional financial products becomes blurred. One revealing detail from the story is a comment from Rushdi Siddiqui, Global Director of the Dow Jones Islamic Market Indexes. Commenting on Shari'ah Capital's Shari'ah-compliant hedge fund for which Sheikh Yusuf DeLorenzo, a member of the Dow Jones Shari'ah Board, serves as Cheif Shari'ah Officer (CSO), he says, "“Islamic finance is about addressing inequality, inaccessibility, justice, preventing the ‘debt trap’ etc. I, and many others, do not see how an Islamic hedge fund addresses the plight of Muslim men and women on the street.” The challenge of all ethically-based investments is that the final call about permissability has to be made by the individual and thus one size will not fit all.

IFSB Chair named, KFH to buy share of Bank Muamalat, Islamic hedge funds

IFSB

The Islamic Financial Services Board has named Dr. Zeti Akhtar Aziz, Governor of Bank Negara Malaysia as its Chairwoman in 2007. Her deputy will be Dr. Shamsad Akhtar, Governor of the State Bank of Pakistan who became the first female governor of the bank in 2006 0following a career working for the World Bank and Asian Development Bank.

KFH, Bank Muamalat & RHB Islamic Bank

Kuwait Finance House, a large Kuwaiti Islamic financial institution has been trying to enter the Malaysian market and is believed to be trying to purchase a 70% stake in the country's second-largest Islamic bank, Bank Muamalat as well as a 32.8% stake in Rashid Hussain Bhd (RHB), the parent company of RHB Islamic bank.

Testing the limits of financial engineering

An article in the Norwalk (Connecticut) Advocate describes the development of products needed to create an Islamic hedge fund by Connecticut-based Shariah Capital (which provides an article on sukuk from U.S. News & World Report a week ago). The article describes how the "firm received fatwas, or religious blessings, on Shariah-compliant investment vehicles that provide an alternative to short-selling and options trading." The key to this description is that the fatawa create Shari'ah-compliant versions of conventional products and their success criteria, therefore, is how closely they match conventional products, while remaining compliant with the Shari'ah. This is described even more succinctly on Shariah Capital's website:

"Shariah Capital is committed to becoming a leader in modern Islamic finance by developing the solutions behind competitive Shariah compliant alternatives to conventional Western financial instruments and investment products. [...] In collaboration with prominent Shariah scholars and Western financial and legal experts, Shariah Capital has developed risk management tools that replicate the economics of conventional short sales, options trading and leverage with Shariah compliant equivalents."

While Shariah Capital pursues more controversial products than many Islamic financial institutions, the way of thinking is common with most other Islamic financial institutions: Let's find a way to have conventional produts re-engineered to become Shari'ah-compliant. This is one way to open a new niche market with a customer base that will pay extra cost to have products that are backed by a fatwa certifying that it conforms to the scholars' interpretation of Islamic law & jurisprudence, but it is not innovative in a way that will expand its market outside of it's niche. Innovation should be directed more towards incorporating the lessons learned from Socially Responsible investing (SRI) into Islamic finance and tailoring SRI to the ethical priorities of Islam. This will create products with appeal to a larger segment of the Muslim community and also, particularly given some of the shared roots between Christianity, Judaism & Islam, could make Islamic finance appealing to non-Muslims as well, which would allow the industry to make an even larger impact.