Kuveyt Turk's sukuk, other news

Kuveyt Turk Participation Bank's recent wakala sukuk was backed by a combination of murabaha receivables and ijara contracts. This is generally tradable so long as 33% of the contracts are ijara contracts. Most of the issuance of this type of sukuk (e.g. by Cagamas and the Islamic Development Bank) adopt a higher 50% level for ijara sukuk. It appears that sukuk backed by murabaha and ijara contracts is becoming more popular among financial institutions since the structure used for mudaraba and musharaka sukuk prior to a 2008 AAOIFI ruling were ruled impermissible.

Other News

• France passed a tax neutrality law for Islamic financial products recently that could encourage more Islamic finance in the country. An earlier law on Islamic financial products was struck down by the high court largely on procedural grounds.
  
• Zawya reviews sukuk activity during August. Much of the activity occurring in August and expected in September is from Malaysia.
  
• Kuwait Finance House, which has a Malaysian unit, is planning further expansion across Asia, including China and is reportedly in talks with Japanese financial institutions regarding a strategic partnership.
  
• An article describes the potential for growth in Islamic finance but notes--correctly in my opinion--that while Islamic financial institutions were less exposed to the financial crisis in general, they have not reacted as quickly as conventional institutions and have been slower to fully recover (particularly in the GCC).
  
• Sukuk returns trailed emerging market bonds in August for the fourth straight month because of continued restructuring talks around some GCC-based sukuk.
  
• Bloomberg describes briefly the Dubai-based institution, Millenium Private Equity, which subscribed for the entire sukuk from UK-based company IIT.
  
• The International Islamic Ratings Agency and Dinar Standard released a report, called "Pulse of OIC Islamic Capital Markets".
  
• Indonesia's government is planning to issue another 2 trllion rupiah ($222 million) in sukuk to the government's haj fund by private placement. Selling the sukuk to the haj fund may be a response to the several failed auctions previously. The previous auctions saw enough demand, but higher yields than conventional bond sales of comparable maturity because sukuk are less liquid than conventional bonds.
  
• Islamic finance in Indonesia has been growing, albeit from a small base of around 2.8% of total banking assets, compared with nearly 20% in Malaysia.
  

How tough is the market for new issues in the GCC?

An article in Bloomberg describes the falling yields on GCC sukuk, Dubai World and the sovereign Dubai bonds and sukuk with some optimism. However, it notes that the spread on Dubai World's debt (it doesn't say what the spread is based on, but one would assume comparable maturity US Treasuries) from 647 basis points after the standstill to 545 basis points (it incorrectly says the spread is 545 percentage points). The yields on sukuk from GCC-based issuers was 7.17 percent on July 23 (compared to 8.76 after the Dubai debt crisis), the Dubai 6.396% soverign sukuk is yielding 7.38% (435 basis points higher than the recently issued Malaysian sovereign sukuk), the Dubai World yield is sitting at 8.4% (for the 6.25% sukuk).

These figures reflect only limited thawing of GCC credit markets in the aftermath of the financial crisis and, in particular, the Dubai debt crisis. It is hardly surprising that other articles written recently describe a move in momentum in sukuk issuance from the GCC to Malaysia. That is in many respects not entirely fair. The Dubai debt crisis was triggered by specific factors--primarily an overvalued real estate market in Dubai that saw significant declients. However, it does suggest a general attitude that sukuk from the GCC are more risky than other emerging market debt (including sukuk) offerings. This will reduce the level of issuance of sukuk in the near term from the GCC, which would hurt the emergence of sukuk secondary markets. If anything, investors need more sukuk issuance to fill the portfolios of long-term, hold-to-maturity investors (like takaful funds) and therefore a reduction in issuance from one of the largest markets (and the regional market for many of the funds investing in sukuk) could reinforce the hold-to-maturity mentality among many investors. Some of those investors are probably sitting on large losses from Dubai-related sukuk that they are unwilling to realize.

Meanwhile, Nakheel is working through its own debt restructuring. Reports suggest that full payment will be made over 5 years for its syndicated banks loans (including Shari'ah-compliant financing) and 7 years for its sukuk. According to Reuters, "Bankers have until the end of August to respond to undisclosed terms of Nakheel's multi-billion dollar restructuring plan, including the rates of interest and repayment schedules for syndicated and bilateral loans. " Reuters is usually pretty good at describing the presence of Shari'ah-compliance in financing facilities, so the description they give (while it may be limited by sources speaking on background) does reflect the lack of a structure for restructuring in Shari'ah-compliant transactions. The restructuring of the loans (many of which are based on ijara) is probably being done in a rather ad hoc manner. The interest rate and payment terms are dealt with first and the Shari'ah-compliant structure are dealt with later. If this is the case, there remain significant gaps in the Islamic finance industry in dealing with distressed situations that should be at the forefront of the agenda before the next crisis comes.

Other News

• Kuwait-based International Investment Group defaulted for a second timek on a sukuk this year, missing a $152.5 million payment.
  
• Mushtak Parker offers his thoughts on the Sukuk ALIM being issued by Cagamas working with Al Rajhi Bank to be viewed as Shari'ah-compliant in both the GCC and Malaysia. He also offers his thoughts on the recent entry into the Islamic finance markets by Japanese firms, several years after the country said it wanted to encourage Islamic finance in the country to attract capital.
  
• A former Supreme Court justice in India, Krishna Iyer, believes that Islamic finance can help in efforts to alleviate poverty.
  
• Arab News has an interview with the CEO of the Islamic Corporation for Development of the Private Sector, part of the Islamic Development Bank group.
  
• The state-owned Islamic bank in the Philippines is planning the country's first sukuk to "fund growth in Muslim Minanao".
  
• A Malaysian firm is providing the first financial guarantee for a sukuk.
  
• A writer in the Business Recorder in Pakistan, Saqib Masood Chisti, suggests that Islamic microfinance could be expanded in the country while criticizing a program that provides cash payments to poor families as causing inflation and creating dependency (I am not knowledgable enough about the program to comment, but the description given resembles the successful Bolsa Familia program in Brazil).
  

Thursday bullets

• The UK courts threw out the case brought by the Investment Dar against Blom Bank, which relieves some questions regarding the ex post enforceability of Shari'ah-compliant contracts where one party claims Shari'ah-non-compliance.
  
• Nakheel will issue the sukuk to its largest trade creditors in mid-July according to a large contractor.
  
• Oxford Analytica has an article about the ISDA-IIFM Tahawwut Master Agreement for Shari'ah-compliant hedging.
  
• Bermuda wants to be an Islamic finance hub and may launch its first Islamic bank or takaful company by the fourth quarter. the Bermuda Stock Exchange wants to see the first sukuk listed on the exchange later in the year as well.
  
• Sumitomo Corp is working on the first Islamic financing deal in Japan. This follows the announcement about Nomura's $100 million sukuk being issued in Malaysia.
  
• AmIslamic's musharaka sukuk received a AA3 rating from RAM Ratings.
  
• Barwa Real Estate received murabaha financing from Qatari Diar.
  
• A Malaysian fund, HwangDBS Investment Management had the top performing sukuk fund in the past year.
  
• Khazanah may increase the size of its planned sukuk to $1 billion if it increases its offer for the hospital operator Parkway Holdings.
  

New sukuk issuance, Islamic banks in the credit crisis

There are a number of articles about planned sukuk:

• Nomura's $100 million sukuk will mature in 2012 and will be priced at 160 basis points over LIBOR. It is an ijara sukuk.
  
• An article describes HSBC's work in the sukuk markets, including its work on the $1.9 billion Saudi Electric Company sukuk.
  
• Kuwait Finance House wants to arrange more sukuk in the GCC and Malaysia.
  
• AmIslamic Bank Bhd received approval from the Securities Commission in Malaysia for a RM3 billion ($932 million) sukuk program. The sukuk will be senior musharaka sukuk with tenors of up to 30 years.
  
• The Indonesian sukuk to be issued in October will be "approximately similar to that of last year". Last year's Indonesian sovereign sukuk was $650 million.
  
• Few other details were provided by Pakistan's government about its proposed sale of short-term (less than one year) sukuk which it will sell in the GCC.
  

Gulf Finance House is in talks to extend $100 million in debts for three years because the markets are not good enough for asset sales. The asset sales are part of a restructuring following a crisis at the bank (described in an article by Mohammed Khnifer, Aatef Baig and Frank Winkler). The GFH situation is indicative (although an extreme example) of the effects of the financial crisis on Islamic finance. Bloomberg reports that Islamic syndicated loans fell 40% to $2.2 billion in the first half of 2010, a 5-year low.

Citi plans to offer more Islamic equity products where returns are based on the performance of the equities under certain conditions and where they receive the stock if the price falls. Citi says it wants to offer mudaraba-based products, but there has been little interest.

A study by Mareyah Mohammed Ahmad, a recent graduate of the British Univerity in Dubai, found that Islamic banks had

Late payment penalties, liquidity management, creating secondary markets in sukuk

An article in Arab News discusses the issue of a fee charged by an Islamic financial institution for late payments. In May, Bank Negara Malaysia's Shari'ah Advisory Council said that charging a fee in case of late payment is allowable and separated out the cases where the bank can and cannot keep it and recognize it as income. In the case where the fee is charged as a fine or penalty (gharamah), it must be donated to charity and not recognized as income. Where the fee is for compensation (ta'widh) for actual loss by the Islamic bank, it can be kept and recognized as income. While the distinction is clear between the two concepts, it seems likely to be difficult to distinguish in practice. Perhaps it might be a better practice for Islamic banks that use this to treat everything as ta'widh until the actual costs of collections are met and only then be able to treat any fees as allowable income. However, it is unlikely that such a solution could be approved because it would not be possible to provide ex ante certainty in the contracts between the bank and its customers. Whether this is used or not, it could allow Islamic banks to increase the total fees to Islamic banking customers, which would make the products less competitive and probably result in a slower growth rate for Islamic banking. It would also complicate the Shari'ah audits because it would require that the fees be reviewed to determine whether the bank has basis for compensation if it used the principle of ta'widh.

A fantasstic article from Islamic Business & Finance discusses the challenges facing Islamic finance in developing short-term liquidity management products, despite their importance. The article specifically looks at the UAE commodity murbaha Islamic CDs, the idea of Shari'ah-compliant repo transactions and an electronic wakala/murabaha platform.

Rushdi Siddiqui has another interesting article in Gulf News, this one covering the issue of where is the hub of Shari'ah transactions, which quickly morphs into the discussion of the lack of a hub. One point that he makes, which I agree with and have made before on this blog, is the lack of secondary markets for sukuk. He takes it one step further adding that even where there are secondary markets for sukuk, they are not deep enough or liquid enough to provide much information. He suggests that the Islamic finance industry needs to 'institutionalize' and 'internationalize' itself, primarily by moving from bilateral price discovery through over the counter (OTC) trading to "multiple price discovery". As much as the effort towards creating secondary market platforms for sukuk will help lay the groundwork for this in the future, it is impossible until there is enough supply to sate the demands of hold-to-maturity investors and leave enough exchange-listed sukuk that can be traded in secondary markets to develop meaningful liquidity that provides more information than bilateral trades in illiquid markets can.

Other News

• Sorouh raised $640 million in conventional and Islamic debt, of which $400 million (AED1.47 billion) will be used to redeem the remainder of the sukuk issued in 2008 which I described about a month ago in a blog post. At the time, there was AED1.5 billion remaining of the AED4 billion securitization sukuk.
  
• Malaysia's central bank, Bank Negara, issued its fourth Shari'ah Parameter Reference which covers musharaka. The previous SPRs covered ijara, murabaha, and mudaraba. The bank also issued a concept paper on takaful.
  
• Bloomberg compares the performance of Shari'ah-compliant equity indices with sukuk indices. Equities have lagged sukuk in the past 2 quarters due to an agreement to restructure $23.5 billion of debt by Dubai World and its creditors.
  
• Japanese firm Nomura Holdings plans to issue a $100 million sukuk in Malaysia, the first Japanese company to do so.
  
• The proposed Islamic Bank of Thailand THB5 billion ($154.5 million) is likely to be issued in the second half of 2010 depending on market conditions. The sukuk will have a 5 to 7 year maturity.
  
• Deutsche Bank's Shari'ah-compliant platform is investing in a foreign exchange strategy, based on "investor demand" according to the managing partner of the advisory firm which will create the strategy using a structured note. Deutsche Bank previously created the controversial Total Return Swap structure that allowed investors to receive a return benchmarked to a group of conventional hedge funds.
  
• Singaporean REIT company Mapletree Investments is launching an Islamic REIT whose IPO may be up to $713 million (S$1 billion). The REIT will be marketed in the GCC by Arcapita.
  

Rushdi Siddiqui interviews four scholars, sukuk update

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

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

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

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

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

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

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.
  

Malaysian standardized commodity murabaha deposits, GCC sukuk issuance 2009H1, Nakheel sukuk update

Malaysian Islamic banking groups approved a Corporate Murabaha Master Agreement which will standardize the deposit murabaha agreement where an Islamic bank deposits funds that are used by the depositor to purchase a commodity and resell it to the bank with deferred repayment on a cost-plus basis. It standardizes a reverse murabaha agreement that is similar to a reverse tawarruq product. The agreement is seen as a beneficial innovation in Islamic money markets by the Association of Islamic Banking Institutions Malaysia (AIBIM) which secured the approval. Reuters reports the product will be similar to the Islamic interbank money markets already in operation. IIFM, an industry body in the GCC estimates that commodity murabaha accounts for $100 billion in annual activity.

Sukuk markets for new issuance in the first half of 2009 continue to be lackluster in the GCC with only $1.1 billion in sukuk issued and all but one of the new issues coming from the Bahraini government through its regular salam and ijara sukuk and a new $500 million longer-term ijara sukuk.

Nakheel and the government of Dubai could have saved up to $1 billion by buying back the sukuk instead of allowing it to mature at par with deferred lease payments in December. I describe this in greater detail in an article forthcoming in Business Islamica magazine.

Other News

• National Bank of Kuwait continues to expand its ownership in Boubyan Bank to increase its Islamic banking industry exposure.
  
• BIMB plans further innovation in its Islamic financial products.
  
• Nomura plans to expand its operations into Islamic finance to attract GCC-based liquidity.
  A RAM Holdings analyst predicts greater growth in the industry in response to the financial crisis although his rationale as quoted in media reports seem to ignore the impact of the financial crisis in exposing speculative bubbles in real estate in the GCC that has had significant negative impacts on Islamic financial institutions that were overexposed to the sector.
  
• The Filipino government is increasing the capital of the sole Islamic bank in the country, government owned Al-Amanah Islamic Investment Bank.
  

Yasaar Media report, Canadian sukuk, corporate sukuk market in the GCC

Yasaar Media released a report on Islamic investment banks recently. I am still reading the report and hope to have a post dedicated to it here and on my blog at Zawya.com. The report is available from Yasaar Media's website (pdf)

The second North American sukuk is expected to come from of Canadian company, Bear Mountain Resorts, by October. The sukuk will fund part of a resort community near Victoria, British Columbia and is expected to be about $380 million. The sukuk is being launched with the assistance of Siraj Capital whose CEO Ibrahim Mardam-Bey worked on the East Cameron sukuk which is now in bankruptcy while he was at Lebanese firm BSEC.

A new fund being offered by Dubai Islamic Bank provides investors with capital-protected returns based on a long-short strategy tracking the Rogers International Commodity Index Enhanced ex-Lean Hog, a commodity index. The structure of the transaction is not specified but seems like it is similar to a controversial product that used a total-return swap on an index and is likely to restart arguments about the products' desirability from a Shari'ah perspective that were raised by Sheikh Yusuf DeLorenzo.

Despite the many sovereign sukuk being issued by GCC governments, the corporate sukuk issuance market may remain largely frozen until 2010 according to Arab Banking Corporation managing director Naveed Khan. The delay between new sovereign issues and new corporate issues is expected to be caused by the higher pricing of the sovereign sukuk compared to where they were before the credit crisis.

Other News

• HBG Holdings will invest in companies listed on London's Alternative Investment Market (AIM) through a Cayman Islands-domiciled Shari'ah-compliant private equity fund. HBG Holdings' shareholders are primarily institutional and private investors from the Gulf region.
  
• One of the sukuk funds launched recently, Emirates Investment Services' Emirates Sukuk Fund No. 1, announced it had gained 8.5% in the first 3 months since inception.
  
• Investors in Saad Group's Golden Belt 1 Sukuk are forming a committee to represent them, according to Reuters.
  
• Malaysia is 'well positioned' to help Islamic finance in Europe according to Malaysia's ambassador to Brussels, Hussein Hanif.
  
• An article about Abu Dhabi National Energy (Taqa) includes the note that the planned sukuk from Ras al Khaimah may offer a coupon between 8% and 8.5%.
  
• In the Islamic finance industry, aggregate size numbers are always rather suspect because there is no centralized methodology on how it is calculated, but according to one article, the industry now has more than $1 trillion in assets.
  
• Despite attempts by the Japanese government to attract Islamic finance, it is having difficulties gaining steam and the Japan Bank for International Cooperation (JBIC) sukuk that has been planned for a while may be further delayed.
  
• Australian investment bank Macquarie is in Malaysia and may be considering issuing a sukuk.
  
• Islamic finance may provide benefits to Muslim and non-Muslim homeowners in Scotland, according to an article.
  

Liquidity risks in Islamic finance; news from Japan and South Africa

An opinion piece in Reuters discusses the possibility for a $10 billion 'mega Islamic bank' to be launched by the end of the year. The most interesting part of the article to me was a few paragraphs that describe the potential for Islamic banks to 'break the buck' on depositor accounts if they suffer more severe writedowns on the real estate projects they financed. Margaret Doyle explains:

"But investors are taking a risk if they assume that Islamic finance is a whole lot safer than its discredited western counterpart. After all, most Gulf banks are heavily exposed to real estate. As Spanish and Irish banks have found to their cost, it is little consolation to avoid complex U.S. sub-prime debt if you are hammered by a local property bust.

"More generally, Islamic banks have yet to test the central tenet of Islamic banking-that depositors are co-investors who share in the risks that they take on. In practice, like U.S. money-market funds, they strain every sinew to ensure they don't "break the buck", or give customers back less than they deposited.

"But big real-estate write-downs could mean that banks do not have enough to repay deposits in full. That would test depositors' loyalty. And many Islamic banks, like their western counterparts, have lent long. Therefore, if depositors turn away from their local banks, they could face a liquidity squeeze just as acute as when wholesale markets closed to western banks in August 2007.

. The bolded sentence was the focus of an article I wrote for Business Islamica magazine last fall that described a hypothetical banking crisis triggered by writedowns on real estate that led to a liquidity crisis following the departure of many depositors afraid their deposits were not safe.

An article on Zawya has an interview with the head of Japanese financial firm Daiwa Asset Management, which recently became the first Japanese company to offer a Shari'ah-compliant ETF which is currently listed on the exchange in Singapore. The Japanese parliament passed revisions to its banking laws in December 2008 that open the way for Islamic finance companies to operate in the country, albeit only allowing them to use a few types of products now, primarily ijara and murabaha.

There is another article that interviews the managing director of the Islamic banking division of Absa, a bank in South Africa.

Other News

• The Dubai government completed a $600 million ijara facility to refinance the ijara facility coming to maturity this month for Dubai Civil Aviation. The emirate has had its ratings outlook cut.
  
• A British website describes the benefits of Islamic banking to an audience of non-Muslims. The head of the Islamic Bank of Britain is quoted as saying: "The concept of sharing profits is quite appealing to non-Muslims as well as Muslims. Up until recently, when banks were making huge profits, the shareholders were obviously taking a share but the depositors were not. I think that grated with many people. Here, the shareholders and depositors are more linked."
  
• The Islamic Bank of Britain is launching its first expansion into the Scottish market. The bank is headquartered in Birmingham and has been exclusively focused on the British market until this announcement.
  
• Malaysian-based airline AirAsia completed an ijara transaction with French investors to finance the purchase of new airplanes, the first French-Malaysian Islamic finance transaction according to the article.
  

Sukuk volume in 2009: opinions differ

An English online grocery store Ocado received £10 million in financing using Shari'ah-compliant leasing (ijara). Although the transaction is small and uses a relatively simple Islamic finance product, it has significance, I think, because it is the company's first use of Islamic finance and it chose this type of finance because of the "competitive offering" from the Bank of London and the Middle East, a Shari'ah-compliant wholesale bank in the U.K. There are relatively few instances where Western companies chose Islamic finance products based on their price competitiveness (e.g., the $166 million East Cameron Gas Co. sukuk), but there is potential for this to become more common if Shari'ah-compliant banks are able to tap sources of capital and have not been hurt themselves by the credit crisis through the slowing of global growth where health companies find that they can only receive finance from conventional banks at extremely high cost.

According to a poll conducted by Reuters, the amount of sukuk expected to come from Southeast Asia, a region with a large volume of sukuk in recent years, is around $5 billion, far below last year. Most of the issuance is expected to be issued by governments. A previous estimate for Malaysia put the volume from that country at $4 billion for 2009. The GCC region is also expected to see far smaller volume of sukuk with unnamed bankers telling Reuters they expect to see issuance between $4 and $8 billion. Standard & Poor's, however, believes there are $45 billion of sukuk in the pipeline and the number that reach the market in 2009 will depend on whether the market becomes more favorable than it is now.

Other News

• Gatehouse Bank announced a new $1 billion 'Milestone Sukuk' platform and a first issue on the platform that it claims makes the issue of sukuk easier.
  
• Islamic financial institution Arcapita Bank, based in Bahrain and Atlanta, Georgia was downgraded recently, in part because of its 'high leverage'. The high leverage aspect is surprising because Islamic finance is often characterized as putting significant limits on allowable leverage.
  
• Turkey's first sukuk, a revenue-linked bond, was a flop raising only about one-quarter of the planned amount.
  
• Organizers of the 2009 Asia Sukuk Summit, in contrast, believe that countries where Islamic finance is just beginning to become into significance like Jordan, Hong Kong, Singapore and Japan will issue sukuk this year.
  

News Bullets

• Paradigm Mortgage Services is the first company to be selected to offer products from the Islamic Bank of Britain.
• Japan-based Bank of Tokyo-Mitsubishi UFJ wants to take a leadership role in the global Islamic finance market.
  
• Takaful premiums in the GCC are expected to grow fivefold in the next 10 years
  
• The CBB salam sukuk was oversubscribed by over 400%. This is the largest oversubscription I can remember in several months which could indicate the beginning of an unfreezing of the sukuk market.
  

Mutual fund screening and the path to Islamic finance by a Japanese bank

Mutual funds designed to meet the criteria of a faith are not limited just to Muslim investors and some funds are moving beyond the Islamic funds in incorporating more proactive actions that do more than just using exclusionary screening. These including becoming activist shareholders and including 'positive' screens that support companies with the highest ethical conduct. I think it is the next step for Islamic mutual funds to become focused on more than just prohibition-based screens.

The path of Tokyo-Mitsubishi UFJ Bank from initially considering becoming active in Islamic finance becoming active in Malaysia with expansion plans elsewhere are described in a short article.

As usual, the sukuk al-salam issued by the Central Bank of Bahrain was oversubscribed, highlighting a continued need for short term investments for investors including Islamic banks.

A Shari'ah-compliant health insurance plan was introduced in Dubai.

Islamic finance may face challenges from economic slowdown; another call for focus on the ethical basis of Islamic finance

Although there has been a lot of suggestion that Islamic finance is immune to the credit crisis (although it may be hurt by the follow on economic slowdown), the Islamic financial industry has not yet gone through a period where the legal structure has been tested if the issuers of sukuk, for example, default. For example, there has not been a challenge of whether sukuk holders have a claim on the asset used to back sukuk. According to an article in Asian Banker, the IFSB says that they should, but the fallout from the economic slowdown may result in an actual test of whether or not sukuk holders get ownership of the underlying asset in the case of default.

A EFG-Hermes report on the UAE says that the merger of Islamic finance companies Amlak and Tamweel will be a balancing act and that "one thing we can be reasonably confident is that while Amlak and Tamweel may make it to the beginning of the year, they are unlikely to make it to the end".

Farmida Bi argues that focusing too narrowly on specific rules as opposed to the intent of Shari'ah guidelines hampers growth and that "If Islamic finance is seen in its true guise as a form of ethical financing, of interest to all rather than only as a faith-based activity of interest to the Muslim population, it is likely to find favour with a different type of conventional investor who would be potentially willing to consider different types of risk-reward stuctures." I wholeheartedly agree that Islamic finance should focus on the objectives (maqasid) of the Shari'ah and should work to attract non-Muslims. This will ensure that the industry does not just become an exercise in structured finance, but promotes a greater ethical cause that is shared among peoples of all faiths.

Japan's largest bank, the Bank of Tokyo-Mitsubishi UFJ is planning to offer Islamic financial services in the Middle East and Asia. Japanese companies have been exploring growth into Islamic finance and some have started to become involved in the industry.

Islamic finance in India is finally beginning to develop some momentum.

UK sukuk document; Islamic finance in Japan

The UK's consultation document provides four options for regulating sukuk (full pdf)range from doing nothing to creating an exemption from certain regulatory requirement for sukuk to put them in a similar regulatory environment as corporate bonds. The transparent discussion of how sukuk are viewed from a regulatory perspective put the UK far ahead of other Western financial centers in promoting Islamic finance. The co-head of the London finance and capital markets team at Clifford Chance, Tim Plews says, "There’s confusion in Dubai as to requirements in other jurisdictions like Hong Kong, so with the U.K. setting the standard, it is providing real leadership".

Japan continues to slowly see an Islamic finance industry develop. Its growth is hampered by tax and regulatory hurdles yet to be overcome as well as a nearly nonexistent domestic demand for Islamic financial products.

IIFM standardized murabaha document finished; sukuk market an alternative to the conventional?

The International Islamic Financial Market (IIFM) announced that it had finished the creation of a standardized agreement, the Master Agreement for Treasury Placement (MATP). The standardized document is primarily used for Shari'ah-compliant deposit products using commodity murabaha. The commodity murabaha product is a somewhat controversial way to replicate a short term loan and is used to address Islamic banks' liquidity management challenge. The move towards standardized documents for common products like murabaha will provide a way to maximize the value of Shari'ah scholars' scarce time by allowing them more time to review innovative or controversial new products.

The secretary general of ASEAN says that companies finding difficulty tapping the conventional credit markets have been turning to sukuk, although issuance is down sharply this year. An article describing why Islamic finance does not allow short selling morphs into a reminder about performance of Islamic banks.

Malaysia's central bank governor says that the reliance on profit-and-loss sharing agreements has insulated Islamic finance from the credit crisis. Because most products are not profit-and-loss sharing in form, it seems to me that the insulation of Islamic finance is provided mostly by continuing strong economic growth in the areas with the most Islamic finance, the GCC and Malaysia.

Islamic funds continue to receive good publicity in the U.K. Islamic finance and banking continues to lag in Egypt while booming in Bangladesh and encouraged in Japan through changes in the regulatory environment. Indonesia continues ahead towards issuing a dollar-denominated sukuk.

JBIC financing, Tamweel into Egypt

Japan Bank for International Cooperation (JBIC) provided its first Shari'ah-compliant financing. The project it is cofinancing is a power and water desalination plant in Qatar, 80km from Doha, which costs $3.9 billion, of which JBIC will provide financing for $1.5 billion.

Tamweel, the UAE-based Shari'ah-compliant home finance company, began operations in Egypt. The Islamic finance market in Egypt, where some of the first Islamic finance companies emerged, has been relatively less successful than many other MENA countries, particularly those in the GCC like the UAE.

DIFC studies standardization, Japanese Diet to allow Islamic finance

The Dubai International Financial Centre (DIFC) is launching a research effort to study the possibility for greater standardization of Islamic finance globally as well as within the UAE and GCC.

A new bill is being proposed in the Japanese Diet to allow banks to begin conducting Islamic finance. While there is very little domestic demand for Islamic finance, Japanese banks see Islamic finance as a way to attract investors from the oil-rich GCC, some of whom often will only participate in investments if they are Shari'ah-compliant.

Islamic banking should continually be aware of its position and competitiveness with conventional banks to ensure that it can continue growing rapidly says Nicholas Brewer. In Malaysia, for example, Islamic banks are used by many non-Muslims because they offer competitive pricing and some aspects of Islamic banking may be viewed as more favorable to the borrower.

An editorial in the Guardian questions whether the literal interpretation of the prohibition of riba as interest may cause some to overlook the greater social requirements of Islam. Overly focusing on 'avoiding interest' but not necessarily having a focus on the underlying reason for the prohibition (and other requirements beyond avoiding interest). It would be possible to create an exploitative payday loan with high cost to the borrower while adhering to a narrow interpretation of the prohibition of riba by using murabaha or ijara (although it would be unlikely to be approved once Shari'ah scholars looked into more than just its form).

Islamic finance goes to Japan, U.K. becoming the center of sukuk

A member of Bahrain's parliament, Jasim Ali, describes a recent presentation he made in Japan urging the country to enter the Islamic financial industry. During the presentation, he noted that the industry is growing rapidly, but is still facing challenges in meeting demand and ensuring that standards are applied consistently across the different countries in which Islamic finance is offered. Another Bahraini MP, Jassim Hussain, was also on the trip to Japan. Bahrain, which issues regular sovereign sukuk, is now the first country to have a sovereign sukuk listed on the London Stock Exchange. The U.K. will likely be the first G8 country to issue a sovereign sukuk.

A financial advisor in the GCC discusses the differences between conventional banking and Islamic banking. An Islamic banking advisor suggests that Islamic financial institutions should highlight the differences with conventional banking as an avenue to promote greater understanding of Islam. Islamic finance continues to grow in non-majority-Muslim countries like the U.K.

The Toronto Star profiles the Ansar Co-operative Housing Corporation, which provides Shari'ah-compliant home financing. Although the model they use has been successful, the cooperative model is limited by the amount of capital available to the cooperative, which is not able to access conventional financial markets or sell of the home financing like a conventional home finance companies (and many Islamic home finance companies in the U.S.) can.

The American Public Media show Marketplace, which recently ran a number of stories on Islamic finance, takes an interesting perspective on the recent controversy about the comments on ijara sukuk by Sheikh Taqi Usmani. The report compares the ratings agencies with Shari'ah scholars--both are paid by the organizations they regulate and both depend on their opinions--and suggest that losing Shari'ah-compliance could force a crisis if Islamic banks are forced to quickly divest non-compliant sukuk, which Sheikh Usmani estimate at 80% of GCC-based ijara sukuk. Unlike the subprime crisis, which was caused by doubts around the AAA ratings, the non-compliance of ijara sukuk are not likely to have as great an impact because there is much demand for them by Western financial institutions and hedge funds not limited by the requirement that their holdings are Shari'ah-compliant.

The chairman of Investment Dar explains how the subprime mortgage crisis could not happen in Islamic finance because of the prohibitions that make mortgage-backed securities not possible (the trading of debt at values other than par is not permitted in Islamic finance).

Asian Investor, a magazine connected with Business Week, sits down with the head of Malaysia's Securities Commission to discuss the growth in sukuk in Malaysia since the first one was issued by Shell in 1990.

Shari'ah-compliant insurance products, takaful has a large growth potential, particularly since it is much more infrequently used than other Shari'ah-compliant financial products.

Asma Hanif has a good introductory article on Islamic finance.

JBIC sukuk

The Japan Bank for International Cooperation, a government organization in Japan, will make Japan the first G-7 country to issue a government sukuk, with the announcement that it will launch a $300 - $500 million sukuk with the technical assistance from Malaysia. In addition to the JBIC sukuk, Japanese financial companies are entering the industry as well.

The IFSB and the Hong Kong Monetary Authority (HKMA) jointly held a conference on Islamic finance and, in particular, ways for Hong Kong to begin catching up with other Asian countries, particularly Malaysia, in developing an Islamic finance industry. The keynote speaker was Dr. Zeti Akhtar Aziz, the central bank governor of Bank Negara Malaysia.