Look forward for the future of Islamic finance, not to the past

Gulf News' financial correspondent Andrew Shouler wrote an article that contains some valuable insights, but much more folly.  The basic idea of his argument is that Islamic finance is different substantially enough from conventional finance that it allowed the industry to avoid most of the impacts of the financial crisis, although he tries to hedge that idea with the idea that Islamic banks were "There are both cyclical and structural distinctions, he suggests. Many Islamic banks were set up in the past decade, and were victims of timing. Yet, holding greater cash reserves is prudent and will bode well, and the potential for liability gathering in terms of deposits is another clear advantage."

He is right that timing has played a big part in the success of Islamic finance, but I would argue that rather than being a 'victim' of timing, Islamic finance benefited from having its growth period recently.  Had Islamic finance developed earlier, it would have had the opportunity to make similar foolish bets as the conventional financial industry.  It would have also developed ways to get exposure to the real estate boom in the US and parts of Europe and given the penchant before the crisis to develop ever more complicated structures (to be the 'first' this or that), there might have even been Islamic CDOs (although probably not Islamic synthetic CDOs). 

And even without the use of CDOs there were plenty of examples of Islamic investment banks that blew themselves up using leveraged bets on real estate (e.g. Gulf Investment House or Arcapita, not to mention many smaller Kuwaiti Islamic investment banks).  And Shouler does give room to this argument by saying: "In the Gulf, while the tenets of Islamic finance helped spare its institutions from certain exposures, they were still, like others, especially vulnerable to real estate."

Where his argument gets things right is on the current prospects for Islamic finance and sukuk refinancings in particular quoting Dr. Massoud Janekeh, head of Capital Markets at BLME: " 'Markets expected a wall of maturities in 2012,' he said, but the refinancing that has actually occurred is 'a huge endorsement' of confidence in the sector and region."

I would not go so far as to say it has been a 'huge endorsement' because of companies like Arcapita which sits in bankruptcy and Dana Gas, which still faces a tricky maturity date coming up for its $1 billion sukuk. 

Where there may be some room for progress in the future is mentioned in a passage where Shouler quotes Faisal Aqil, Deputy CEO, Consumer Wealth Management, Emirates Islamic Bank and Dubai Bank, "Partnerships between banks and their customers that include the essential concept of profit/loss sharing have been “one of the main factors that helped Islamic banks withstand the widespread effects” of the crisis, he says, so that Islamic finance is perceived increasingly as a “credible substitute” for conventional banking business."

There are possibilities in the future to create debt alternatives that have partnership features and shared profit connected to shared risk which I described in my latest newsletter.  However, looking backwards, it is factually incorrect to say that profit and loss sharing have impacted Islamic banks' ability to survive the crisis because for the most part, they do not use profit-and-loss sharing products (murabaha and ijara, which replicate conventional debt structures in their economic outcome are much, much more common). 

Shouler concludes with something that I wish would be true, but is unfortunately not the world we live in within Islamic finance: 

Ultimately, Janekeh draws a parallel between the lessons of the crisis generally and the specific characteristics that Islamic finance brings. Though it is still a niche sector, IF “will contribute with its simplified structures and ethical dimension” to the aftermath, he argues. “If you look at the global initiatives, you will see many of these features.”

There are many things that I can say about Islamic finance that give hope for its future as an alternative for conventional finance, but 'simplicity' is not one of them.  There are places where there could be more simplicity (e.g. post-AAOIFI ruling mudaraba sukuk) where assets with stable distributions could be pooled to create a product that offered an alternative to conventional bonds.  However, this is not the direction the industry is going.  Instead the product mix (and sukuk in particular) are becoming increasingly complex instruments, although thankfully not as complex as some of the pre-financial crisis issuance like the Nakheel Pre-IPO convertible sukuk. 

The Islamic finance industry should aspire to greater simplicity and find areas like SME financing or agriculture financing where it can make a positive impact, or trade finance where it can offer an alternative to conventional finance that makes use of the classical contracts more in line with their classical uses (rather than using them as building blocks in complex structured finance transactions).  Trying to rewrite the history of the financial crisis and the way that Islamic banks operate is the wrong way to promote Islamic finance as a viable alternative to conventional finance.  Fortunately, there are better ways that Islamic finance can contribute to the market especially now that public opinion of conventional financial services are near their low point.  That should be the focus. 

The "Immunity" Myth, debunked by the IFSB

"At the IFSB, we share in the general assessment that Islamic finance has been resilient to the global crisis, but Islamic finance has not escaped the crisis and it is certainly not immune to it." - IFSB Secretary General Jaseem Ahmed

The IFSB held its 9th summit in Istanbul and Secretary General Ahmed laid out a few goals in his speech, but I think most critically for the industry gave the above quote that effectively renounces the widely parroted view that Islamic finance is somehow immune from crisis.  This is important because the view that Islamic finance is immune from crisis (or even from the most recent financial crisis) is one of the damaging viewpoints for the industry's development.  It is critical that the Islamic finance industry recognize that it is connected intimately with the global economy (including the conventional financial industry). 

Islamic finance must learn from the failures of the conventional finance industry lest it repeat the failures, especially since it already has been swept into the crisis with the massive real estate boom in Dubai that became speculative and led to its own crisis.  It is true that the Dubai property boom was fueled in large part by conventional financial institutions, but Islamic finance was not immune from the greed-fueled run-up. 

One need only to remember that the trigger for the entire Dubai debt crisis was the likely inability of Nakheel to repay a massive sukuk that came due in December 2009.  I wrote about the prospects for the holders of that sukuk at the time and noted that, although it was guaranteed by Dubai World (unlike the other Nakheel sukuk) there was no direct sovereign recourse, making repayment unlikely without a bailout. 

That bailout of course did come, from Abu Dhabi, which loaned Dubai $10 billion to repay, in part, the $3.52 billion Nakheel sukuk. The important point in rehashing the Nakheel sukuk bailout is to remember what the sukuk was financing (or at least the asset underlying the sukuk).  It was a strip of desert that was envisaged to become a huge development (and the value of its appraisal was based on these plans).  After the near-default, Nakheel struggled to craft a resolution for its creditors, a high point in the crisis in my mind since most of the claims were adjudicated by a tribunal made up of foreign judges under the laws of the DIFC (which are based on English law). 

However, for trade creditors, the situation was not quite as predictable since they were paid partly in cash but partly with a sukuk backed by land under the Persian Gulf.  Essentially they were given a back-door version of a (now) common 'extend-and-pretend' refinancing which gives some remedy (you might get some repayment, just not now), but also avoids the type of public restructuring that Arcapita is now engaged in (I personally favor the route forced on Arcapita since it gives more transparency).

Circling back from a rather long digression, the next step from the admission by the Secretary General of IFSB that Islamic finance is not immune from crisis is to develop a reaction to the next crisis, whether that crisis hits just one institution or the global economy.  The first order of business is to consider the idea of how bankruptcy or other resolution for failed institutions could work (a primer on the implications of bankruptcy of a Shari'ah-compliant financial institution are described in a paper by Michael McMillen). 

The next is to continue the focus of developing tools for Islamic finance institutions to avoid reaching a Lehman moment, since bankruptcy for financial institutions outside of a formal resolution process can turn messy and lead to contagion.  The keys for avoiding cascading failures is to have short-term liquidity management tools that are not tied up in the perceptions of solvency of a counterparty that doomed Lehman when times turned bad. 

The best solution for Islamic financial institutions would be to have a robust liquidity management system that offered both nearly risk-free assets like those that will eventually be issued by the International Islamic Liquidity Management Corporation (backed by many counties' central banks) and repurchase (repo) facilities in each country that will allow Islamic financial institutions to borrow against the IILM-issued assets.  Let's all thank the IFSB Secretary General for stating a point which is clear to all of us who paid attention to the financial crisis, but which was ignored by people who continued to describe Islamic finance as 'immune' from crisis, and get to work on making Islamic finance as robust as possible against future crises. 

UAE sukuk market evolution

An article from the Business & Banking Review (via Zawya) describes the evolution of the UAE sukuk market.   One of the most interesting parts of the article (the whole thing is well worth a read) comes at the beginning:

In 2004, only three sukuks were issued in the UAE with an aggregate value of $1.165 billion. Two years later, the number of sukuk issues had increased to seven and the value grew eight-fold to $8.755 billion. The height of the sukuk market was certainly 2007 with eleven issues with a value of $10.8 billion.

What is interesting to me is not the growth (827% over four years), but the average size of the sukuk issued in the UAE, which grew from about $385 million in 2004 to $1.25 billion in 2006 and nearly $1 billion in 2007.  This size is significantly larger than many of the sukuk issued since the financial crisis (excluding some of the sovereign issues from Malaysia).

Many of these sukuk were for real estate-related projects, or for financial institutions which financed real estate investment.  While it is not unusual to see a large volume of sukuk (and conventional bonds) come from financial institutions and real estate companies, the large size of the projects in the UAE (particularly Dubai) were financing a real estate bubble, in many cases supported by the government (the issuers were often partly state-owned or quasi-government companies).

During the boom, these sukuk were snapped up quickly, as demand for nearly any sukuk overwhelming the supply, even in the mega sukuk (a significant amount came from the three Nakheel sukuk, $2.5 billion issued in 2006, $750 million in 2007 and $3.6 billion in 2008).  Now that the sukuk markets are recovering to some degree, the demand is still there, but it is not being met by mega-sukuk.  In many cases (for example, when GCC-based institutions have traveled to Malaysia to issue sukuk), the average size has shrunk significantly, although there are still a good share of "benchmark" sized sukuk.

This is not a bad thing for the market overall.  While a smaller issue may not generate the same secondary market liquidity (given the proclivity of many buyers to hold-to-maturity), they provide more diversity in issuers, currency, ratings, industry, etc.  This is positive because it provides more opportunities for sukuk investors to diversify, so long as they can get an allocation of new sukuk or find them in the secondary market, which is never a given.

Overall, however, I think the current situation is preferable because 1) there was little secondary market activity in the sukuk pre-crisis; 2) there were far too few diversification possibilities for investors away from real estate and related financial institutions; and, 3) the real estate on which the sukuk were based turned out to have been overvalued, leading to a near collapse of the primary market for sukuk.  Risks remain from a global economic slowdown and geographical diversification is still nearly impossible.  However, the market is on the right track.  Again, I would suggest reading the whole article because there is a lot more there. 

Nakheel sukuk--a partial success

The article is not yet up on its own, so no link yet, but in the most recent issue of The Islamic Globe has a good article on the new Nakheel sukuk, which was issued last Thursday to trade creditors of the troubled real estate developer.  The sukuk was part of a deal which included 40% of trade creditor claims paid in cash and the remaining 60% in a tradeable sukuk with a 10% coupon.

As The Islamic Globe's Paul McNamara writes, "Almost as soon as the Sukuk were issued, they were being sold by trade creditors hungry for cash and happy to get 84 cents on the dollar in spite of the hefty 10% profit rate the Sukuk paid to holders".  The article points out that using a sukuk--rather than a conventional bond--added costs, but shows "that Islamic finance is moving out of the realm of specialist niche and into the mainstream of finance".  I am not entirely convinced that this is the case, although the Nakheel sukuk does add another high-yielding sukuk and is reported to be trading like one, with a yield north of 15%. 

Issuing a sukuk to pay claims to trade creditors--by a company with a limited ability to pay out cash--is probably a smart move.  They get the publicity from issuing a sukuk, they give trade creditors a way to get some recovery (even if it is nearly 2 years after the problems started) and provides distressed debt investors with an opportunity to bid for around $1 billion in high-yielding sukuk.

Whether the sukuk works out for investors is a different story and we have 5 years to speculate about the possible outcomes, but in the meanwhile, we can watch at least a partial success for Nakheel's trade creditors as they recover some of what they are owed by the company. 

Dubai update, Islamic finance & foreclosures

Dubai will issue at least $1 billion in bonds in two tranches, one of 5-year tenor and one of 10-year tenor. The (conventional) bonds would be the first issued by Dubai since the debt crisis sparked by the near-default of the Nakheel sukuk. Nakheel, which has received 85% approval from trade creditors, close to its target of 95 percent acceptance, is reported to have applied for listing of $1.6 billion in sukuk with NASDAQ Dubai. The sukuk will be issued to pay 60% of the trade creditors' claims, with the remainder being paid in cash.

In other Dubai-related news, Dubai Islamic Bank took a majority stake in Tamweel, the troubled Islamic mortgage company in Dubai, which led to a sharp rise in the price of Tamweel's sukuk. The move reduces the prospects of a merger between Amlak Finance and Tamweel, which was reported to be likely as a way of dealing with the troubled Islamic mortgage companies. Tamweel has also begun foreclosures on properties owned by people who have left the Emirate and they say in cases where people are still in the Emirate, they are trying to "find a resolution which is satisfactory to both". The issue of default and foreclosure on Islamic mortgages is one that should be balanced between the commercial needs of the mortgage holders and the ethics underlying Shari'ah, which urges lenders to be patient with borrowers who run into financial difficulties.

In general, the commercial logic will outweigh the ethical obligation to work with creditors to avoid causing undue harm for the creditor. However, this is an area where I think Islamic finance can set itself apart from conventional finance. In the post-credit crisis where foreclosures have become commonplace, there have been a number of reported excesses where banks have been overzealous in foreclosures: GMAC Mortgage has come under investigation for problems with the legal documentations and in a bizarre incident, a man in Florida with no mortgage had his home foreclosed on. In many foreclosures, there is no hope for the borrower to become current on the mortgage and foreclosure is nearly inevitable. However, there are many other cases where a negotiated settlement can be reached that is better for the borrower as well as for the lender, who will see a higher recovery value than if they foreclosed on the property and sold it into a depressed market. And one solution that has been proposed (for the conventional market) would seem ideal for an Islamic bank committed to moving towards greater profit-and-loss sharing. Instead of foreclosing on the property, there would be a negotiated refinance into a more affordable mortgage and in exchange for the concession, the lender would have right to a share of any appreciation in the home price when it is sold.

Rushdi Siddiqui focuses his latest column on the need for "reflection, reassessment and reality check" (his 'R-cubed'). He makes some great points including some that I have also highlighted like the problem facing takaful providers (none of which have failed to date): "The link between Takaful operators and Islamic investing is close, as premiums must be deployed in a Sharia-compliant manner. Although there have been no bankruptcies announced in the Takaful industry since beginning of 2009, there have been challenges."

The Lawyer has a great article on the effect of Sheikh Usmani's comments on sukuk, which were followed by a ruling from the AAOIFI Shari'ah Board, as well as the financial crisis. It cited a KFH Research/NCB Capital report on the recovery in sukuk during the past year.

• Efforts to establish an Islamic bank in South Korea have faced significant hurdles.
  
• An article in the National says that Islamic finance can thrive in Dubai. The article notes that Islamic finance is based on an opposition to excess and describes the cause of the financial crisis as "excess risk, excess rewards, excess concern with short term results" without explaining how some companies--most notably Nakheel, which financed many projects with sukuk--became ensnared in the crisis themselves.
  
• Nigeria plans to issue a sovereign sukuk within the next 12 months as it tries to become the Islamic finance hub for Africa.
  
• Indonesia plans to issue 1 trillion rupiah from sukuk in an auction on October 5.
  
• Armen Papazian, a fellow of the Judge Business School at the University of Cambridge, says that Islamic finance should focus on creating an entire financial system based on Shari'ah-compliance, not just individual products.
  
• Standard Chartered is launching a nostra account product in the US for international clients that will be based on commodity murabaha.
  grow significantly and the VP of global wealth management at HSBC Amanah, Shahzad Wairach, estimates its potental of "20 percent growth over the next three to five years".
  
• Bank of London and the Middle East is planning to offer a Shari'ah-compliant Absolute Return Fund that is "in no way a hedge fund". Efforts to create Shari'ah-compliant hedge funds have been criticized for their synthesized short sales.
  
• The Central Bank of Bahrain's latest issue of sukuk al-salam was oversubscribed.
  
• Kuwait's banking system has 35 percent of assets in Islamic banks.
  

Friday Bullets

• The future of Islamic finance--outside of retail banking--is moving more towards asset management with institutions realizing that the recurring revenue from this business is important to offset the highly cyclical nature of investment banking. No institution perhaps stands as a better example of overreliance on private equity/investment banking in Islamic finance than Gulf Finance House, which is planning to build its recurring revenue business now that it has extended the maturity of several loans.
  
• Pakistan's central bank is urging Gulf-based Islamic banks to open branches in the rural areas of Pakistan as a way to increase the country's share of Islamic banking assets, which the bank wants to double in the next 3 years.
  
• A few more articles came out on the Deloitte report on Islamic finance. One article from Gulf News includes two charts from the report that point to the need for regulation, particularly in accounting standards, risk management, corporate governance and Shari'ah standards & compliance.
  
• Adnan Ahmad Yousef, CEO of Al Baraka Banking Group, says that sufficient financing is available for Islamic financial institutions and the banking group is planning a $200 million sukuk to finance the bank's expansion into France next year. Qatar Islamic Bank is also planning a sukuk issue of up to $750 million when market conditions are right, according to a statement from the bank.
  
• An article describes the enforcement of an ijara-based financing in Dubai that went through the UAE court system.
  
• The Islamic Bank of Britain released results for the first half of 2010.
  
• The Nakheel 5-year sukuk to pay trade creditors may be issued by year-end and is estimated to be up to $3.2 billion. It will pay a 10% coupon semi-annually, will be tradable and will be listed on NASDAQ Dubai.
  
• An article in Arabian Business highlights the degree to which credit conditions in sukuk markets have recovered this quarter (and also the amount they still have to go before conditions normalize): "The spread between the average yield for Islamic bonds in the UAE and the London interbank offered rate shrank 104 basis points to 507 basis points so far this quarter, according to the HSBC/NASDAQ Dubai UAE US Dollar Sukuk Index." Issuance is expected to be as much as $5 billion in the fourth quarter, the highest since Q3 ofo 2007, before the AAOIFI ruling and the impact of the financial crisis caused a sharp decline in the volume of sukuk issued.
  

Tahawwut slow to catch on in the GCC, Nakheel/Dubai World face trade creditors' claims

Lack of familiarity with derivatives products in the GCC has hampered the adoption and use of the Tahawwut Master Agreement for Shari'ah-compliant derivatives. There is also some skepticism that the implementation of the product is Shari'ah-compliant because the Master Agreement is just a template and not a specific product.

Although Nakheel has offered to pay trade creditors 40 percent in cash with the remainder in a tradable sukuk yielding 10%, several of Dubai World's trade creditors have taken their claims to the Dubai World Tribunal set up at the DIFC. Nakheel needs 95% agreement in order to issue the sukuk to pay the deferred portion of the amounts owed to trade creditors. One of Nakheel's trade creditors, Construction Delivery Group filed suit with the tribunal claiming it is owed Dh 50 million (13.6 million) for a construction management contract.

Other News

• Mushtak Parker provides a good assessment of an IMF report that found that Islamic banks fared better during the financial crisis.
  
• A study from Deloitte found that 79% of executives believe Islamic finance is growing. 66% believe the industry is under-regulated.
  
• Indonesia may issue a global bond or sukuk for $650 million in the first quarter of 2011. Jordan formed a committee to study the changes needed to be able to issue sukuk and a statement from a government official stated that the government is "serious about using Islamic sukuk to provide funds for carrying out vital and top priority projects.
  
• Citigroup, which co-managed the Kuveyt Turk sukuk says it is in talks for more corporate sukuk issuance in Turkey. AmIslamic Bank in Malaysia issued RM550 million in 7-year sukuk.
  
• The governor of the Kuwaiti central bank says that with five Islamic banks, the market for Islamic banking is saturated.
  
• RAM Islamic projects that the sukuk market in Malaysia will continue to grow.
  
• Qatar First Investment Bank and Gulfmena Alternative Investments are launching an Islamic asset management firm. Allfunds Bank launched an Islamic Services Unit to provide a B2B fund platform of Shari'ah-compliant funds.
  
• Luxembourg will host the 8th Annual Summit of the Islamic Financial Services Board (IFSB), the first time it has taken place in the EU. Luxembourg is the only EU member country that is a member of the IFSB.
  
• Zawya and the Ethica Institute of Islamic Finance announced a partnership for Islamic Banking certification and training.
  
• Pakistan, Afghanistan and Senegal see Islamic banking as a way to bring underbanked people into the financial system. Bloomberg updated its list of planned and expected sukuk.
  
• The Central Bank of Bahrain's 6-month sukuk al-ijara was heavily oversubscribed with BD62 million (US$164 million) in subscriptions received for the regular BD10 million issue.
  

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

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

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

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

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

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

Other News

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

ISRA Shari'ah scholar certification

The plan by ISRA to set up a global certification for Shari'ah scholars is proceeding and the body expects to pick a board of regulators to develop the qualifications by year-end. The goal of the certification is to ensure that all Shari'ah scholars have requisite training and competence not only in Shari'ah, but also finance. I believe the primary beneficiaries of the qualification will be the less well known scholars who may find more demand for their services with the certification providing some confirmation that they are qualified. However, there will remain significant momentum among particularly the global financial institutions to recruit the highest profile scholars to their Shari'ah boards as a way of enhancing their reputation as being Shari'ah-compliant.

Other News

• Moody's Investor Services and Mashreq Capital DIFC believe that the Nakheel trade creditor sukuk will spur secondary market activity in sukuk because many trade creditors will sell them.
  
• Dana gas and Aldar's convertible sukuk performed well in the first two months of the third quarter, with their yield falling from 13.6% to 10.77% (for Dana Gas). The GCC sukuk market has been slow since the financial crisis and the AAOIFI resolution on sukuk.
  
• Padiberas Nasional Bhd issued sukuk as part of a RM750 million ($240 million) sukuk program. While issuance has rebounded in Malaysia, it has remained sluggish in the GCC following the Dubai debt crisis last fall.
  
• The National Bank of Ethiopia is close to approving a directive to allow Islamic banks and Islamic windows at conventional banks. Stanbic Bank in Tanzania, which launched Islamic financial products earlier this year, submitted an application to the country's central bank to widen its product offering.
  
• An article on an Islamic finance conference in Switzerland provides a good summary of the challenges facing Islamic finance if it wants to become more attractive and attract non-Muslim clients.
  
• An article from Trade Arabia discusses one small part of the Islamic financial industry that is Islamic exchange traded funds (ETFs)>
  
• Sudan delayed its planned $300 million sukuk issuance again citing the financial crisis.
  

Indonesia sukuk, rules on forward currency transactions, ISRA to set up Shari'ah scholar org

Indonesia sold sukuk through a private placement for 336 billion rupiah ($37.45 million). There was an indication that the government would move away from the auction method towards private placements after several auctions where the yields demanded by investors were higher than the Ministry of Finance was willing to expect. The higher yields versus conventional bonds were attributed to lower liquidity in secondary markets for sukuk compared to conventional bonds in Indonesia, something that is common in other countries as well. The current issue is non-tradable sukuk with a yield of 7.3% maturing in 2014.

The Shari'ah Advisory Council of Bank Negara Malaysia, the country's central bank, ruled that no payment can be made in exchange for a forward currency transaction used for hedging (based on a binding promise, wa'ad). The basis for the ruling was that the upfront fee would turn the transaction into a bilateral wa'ad, which is viewed as a contract, which is not permissible. The unilateral (binding) promise is viewed as acceptable because it is a promise made without compensation. The issue of bilateral wa'ad also emerged as a stumbling block in the IIFM report on sukuk repo transactions.

The International Shari'ah Research Academy for Islamic Finance (ISRA) may set up an international body for Shari'ah scholars with the hope of creating a (self-)regulatory organization for Shari'ah scholars. Currently, there is no international body that regulates Shari'ah scholars, although the procedures for Shari'ah-compliance are standardized through AAOIFI and the IFSB. I think it is a good effort, but I agree with Muneer Khan, head of Islamic finance at the law firm Simmons & Simmons, who is quoted saying that "It's very difficult to set up an international body which actually has the power to effect these changes [...] It all depends on voluntary cooperation. A lot of work would have to take place behind the scenes to get regulators to sign up".

The editor of Arabian Business, Damian Reilly, wrote an opinion piece in the paper about Moody's recent downgrading of Bahrain's rating from A2 to A3. He says that, despite Moody's claim that the ratings downgrade was based on its budget deficits and dependence on higher oil prices of $80 to balance its budget, it was based on Moody's view that the outlook for Islamic banking in 2011 was diminished. The Moody's analysis also cited the size of Bahrain's banking sector--much of which is Islamic banks--that has assets of three times the country's GDP. Mr. Reilly counters that the large size of Islamic banking as a share of the country's banking sector--and that industry's better performance in the financial crisis--suggests that Moody's is becoming more cautious on Islamic banking. In my opinion, his point avoids the real detriment that a global recession can have on an Islamic banking system. Even if the Islamic banking system performs better than conventional banks, the government would find it hard to support the banking industry if things became worse. The budget deficit is currently 7.3% of GDP (expressed another way, 2.4% of total banking assets) and even a small requirement for cash from the government by the banking industry would have a disproportionally large share of the country's GDP and also a large increase in the budget deficit, which could make the country's creditors uneasy.

JP Morgan estimates that the tradable sukuk paid to Nakheel's creditors for 60 percent of what they were owed (with the remaining 40 percent paid in cash) are worth about 60% of their value if they made all principal and periodic payments. The estimates of their fair value is based on Nakheel being able to pay "almost all" coupon payments but JP Morgan doubts Nakheel's ability to repay the principal in 2015. The five-year sukuk have a coupon of 10% per year. The terms of Nakheel's payment to trade creditors was higher than their offer to debt holders of Dubai World, who extended maturities of debt with a 1% yield. The holders of Nakheel's 2009 and 2010 sukuk received redemption in full with funds from the Dubai Financial Stability Fund and the 2011 sukuk are expected to be repaid in full from the same source.

Other News

• The Islamic Development Bank's $3.5 billion sukuk program securities will be listed in Kuala Lumpur and London. So far $1.1 billion has been issued and another $1 billion will be issued by year end in 5-, 7-, and 10-year sukuk. This is separate from the RM1 billion sukuk that was listed on Bursa Malaysia yesterday.
  
• The bill to put sukuk on equal footing with conventional bonds in the tax code in South Korea has been held up by the (unfounded) concern that it could lead to money laundering and financing of terrorist groups. This is unfortunately not an isolated case where unfounded fears hamper the growth of Islamic finance.
  
• The East Asian region lead the Dow Jones Islamic Indices in August according to a report from Dow Jones.
  
• Affin Bank has applied for the first Islamic bank license in China, according to an article in Business Times. The Ningxia Hui Autonomous Region was working in 2009 to develop a pilot Islamic financial services institution in northwest China.
  
• Indonesian bank BNI Syariah wants to partner with foreign investors to expand its Islamic banking business.
  
• Another article discusses the dichotomy between the GCC and Malaysia in the state of their Islamic finance sectors, primarily new sukuk issuance.
  
• The CEO of the Qatar Exchange, Andre Went, says it is drafting new rules to cover trading in bonds and sukuk. Trading was expected to begin in September, but Mr. Went did not say when trading would begin.
  

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 Director of Treasury and International Banking at Bank Muamalat in Indonesia says that the country's Islamic banks may be undercapitalized because none has equity exceeding $200 million. In the last three years, the number of Islamic banks has increased from 3 to 10. The Indonesian government may cancel its global sukuk because domestic conventional bond sales may be sufficient to cover the budget deficit.
  
• Nakheel outlined a restructuring plan covering $10.5 billion in bank debt. Creditors have until August 31 to respond. The debt plans are being linked with lowering yield spreads on GCC sukuk.
  
• Nomura raised $70 million from a commodity murabaha facility in the Middle East following its $100 million sukuk issued in Malaysia. The sukuk will be listed on Bursa Malaysia.
  
• Although Abu Dhabi Islamic Bank updated its sukuk program prospectus, it has "no immediate plan" for a sukuk sale.
  
• Paul McNamara, the co-founder of Yasaar Media, wrote a book on marketing for Islamic banks available as an e-book.
  
• Kuwait Finance House may announce a $266 million first half profit according to unidentified sources.
  

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.
  

Dubai World, Nakheel update

The Dubai World agreement in principle is described in a Gulf News article that describes in broad terms the level of write-downs banks holding Dubai World debt will have to take. The article, however, does not address whether I was correct in calculating a 40% reduction in Dubai World debt although it does present the total debt being restructured as being $23.5 billion with total debt after the restructuring of $14.4 billion. Nakheel's restructuring, which appears to be separate from Dubai World's restructuring, has already been approved by 50 percent of creditors, is expected to be approved by at least the 65% of creditors required within 2 weeks.

Other News

• The JAFZ sukuk is scheduled to make a distribution payment of $128 million on Thursday, May 27th.
  
• Analysts at the International Islamci Finance Forum 2010 predict that Islamic banks will manage $4 trillion in assets by 2020. This is roughly four times the current size, although statistics about the size of the industry are often unreliable.
  
• OIC countries, led by Malaysia, may launch a clean energy development bank to promote renewable energy projects in OIC-member countries.
  
• Bank Negara Malaysia governor Zeti Akhtar Aziz says that the cental bank is developing financial instruments "that will facilitate cross-border transactions by financial institutions to improve liquidity in the Islamic banking system".
  
• The Malaysia Airports Holding Bhd is planning MYR2.5 billion in sukuk and conventional bonds. The sukuk portion will be MYR1 billion.
  
• An article provides additional commentary on the newly announced sukuk from Malaysia.
  

Nakheel repays its sukuk, FT Special Report

The Nakheel restructuring discussions continue as Nakheel repays the Nakheel Development 3 sukuk for $980 million (Thursday) with assistance from the Dubai Financial Support Fund. The trade creditors of Nakheel are close to approving the deal which would pay them 40% in cash with the remainder in a "publicly traded security with a 10 percent per annum return". Previous reporting said the security would be a sukuk, which is not mentioned in the latest news. AFP reports that 50% of trade creditors have agreed to the plan; 65% approval is needed for it to be approved. One interesting piece of information contained in the article that I had not seen explicitly mentioned was that upon the approval of a restructuring plan, Nakheel would no longer be part of Dubai World and would instead be owned directly by the government of Dubai. The repayment of the Nakheel sukuk is described as a part of the debt restructuring plan for Dubai World.

The Dubai World debt restructuring is an extremely complex process with many different stakeholders with different goals. However, it appears that there has been differential treatment of various parties without regards to their seniority (excepting the initial Nakheel Development sukuk). The first Nakheel sukuk provided sukuk investors with a mortgage over the underlying (undeveloped) properties, but the trade creditors, investors in Nakheel Development 2 and 3 sukuk and the other debt holders are all unsecured creditors of either Dubai World or one of its subsidiaries. In general, a restructuring should (in my opinion) treat all unsecured creditors equally if the debt restructuring for all entities (with the exception of excluded business like DP World) is done at once. In the current deal, all investors are theoretically being repaid at par but sukuk holders receive their payment upon the scheduled maturity dates while trade creditors receive 40% cash payment with the remainder paid in the form of a tradable security and other creditors have maturities extended with a 1% interest rate being offered.

There are good reasons for some of these developments--the Dubai government recognizes that trade creditors receiving cash on their claims (at least on a portion) will help the local economy. Paying sukuk holders on the near-term maturity will avoid default. However, it is troubling for the Islamic finance industry as a whole because it could create a perception problem for the industry. In general, the products used in Islamic finance are created to mimic conventional bonds, but their robustness in cases of default is unproven. A default by Dubai World on sukuk could have ripple effects because it was viewed (incorrectly) as a quasi-sovereign issue. However, on-time repayment of the sukuk while other creditors see the maturity extended and the interest rate dropped could make companies less likely to consider sukuk.

The rationale is somewhat convoluted, but I will try to explain it. A company that uses both conventional and Islamic forms of debt finance brings a conventional unsecured, senior bond to the market. Before that bond matures, the company issues an unsecured, senior sukuk (equal in seniority with the conventional bond) to diversify its funding sources that makes up a relatively small share of the company's total debt. When the time comes to roll over the conventional bonds, the investors balk at the debt pointing to Dubai World and asking "If you run into trouble, will the sukuk certificateholders have de facto seniority over the bond holders? Will they be repaid while we wait for a debt resolution?". The prospects for the issuance of sukuk by a conventionally financed company to create investor concerns among conventional bondholders could make such a company think twice about issuing the sukuk in the first place. This would deprive the Islamic finance industry and sukuk markets of a large group of potential issuers and will slow the growth of a portion of the industry, but not just investment banks who work on the sukuk issuers. Takaful companies, for example, will see the shortage of sukuk accentuated if potential issuers do not issue sukuk for this reason.

The Financial Times has a special report on Islamic finance. Rather than try to summarize each article, I will just list the articles and recommend them all:

• "Derivatives: 'In need of robust architecture'"
  
• "Rich potential in emerging markets"
  
• "Products: Industry 'strays too far from its roots'
  
• "Hedge funds: Industry once more at centre of attention"
  
• "Malaysia: Ahead of the game in local contest
  
• "Sukuk: Sustained recovery expected in second half of the year"
  

Other News

• Differences in interpretation and the lack of enforcement powers by standardization bodies like AAOIFI could be hindering the Islamic financial industry's growth.
  
• Bahraini Islamic investment bank Elaf Bank was appointed to arrange sukuk for two Indonesian companies.
  
• Dubai Islamic Bank approved a wakala agreement with the Ministry of Finance. The wakala agreement converts a $1 billion deposit by the government that was part of efforts to shore up local banks in the wake of the debt troubles at Dubai World.
  
• An article in the UK looks at Islamic ETFs from iShares available in the UK.
  

Should this blog include a newsletter? Islamic venture capital

I received a suggestion from a reader this weekend for a regular email newsletter of this blog, to complement the blog itself and the ability to receive the blog posts via RSS feed. I have thought some about providing a newsletter either weekly (with the week's posts and a teaser) or an email newsletter sent out when I post a new post. However, I would appreciate reader's feedback on whether this would be useful and what the most useful frequency of email newsletter updates would be. Please comment either on this post or by emailing me at blake@sharingrisk.org

Rushdi Siddiqui's latest article in Gulf News deals with Venture Capital, specifically the lack of it within Islamic fiannce. I wholeheartedly agree with him on that point.

Lahem al-Nasser of Asharq Al-Awsat has a dream for Islamic finance:

"I have a dream that one day Islamic financial institutions will operate based on the principle of partnership rather than debt in the sense that all parties would share both risk and profit. I have a dream that Islamic financial institutions will not base profit on usury that will cause them to be weak and fragile.

"I have a dream that one day Islamic financial institutions will have clear strategies to set up important development projects in their societies in a way that contributes to reducing unemployment, increasing productivity in society, improving technology and adopting and strengthening creative ideas. I have a dream that Islamic financial institutions will create genuine products rather than alternative ones through which they could change the conventional view of the financial institution. I have a dream that the joint Islamic financial market will be based on relying on its own tools away from imitating derivatives, bonds or other tools of Islamic banking.
[...]
"I have a dream that Islamic financial corporations will be able to convey Islam's civilized message to the world just as our merchant Muslim ancestors did. I have a dream that one day Muslim businessmen will make this dream come true.

Other News

• The government of Dubai formed a committee of creditors as we enter a week that will see the maturity of one of Nakheel's sukuk (Thursday).
  
• Malaysia may sell 10-year dollar-denominated bonds in June, although it was not specified whether these would be conventional bonds or sukuk.
  
• Emirates Steel is close to receiving $2 billion in loans, of which $1.5 billion is expected to come in the form of Islamic finance facilities. The closing is expected in June.
  
• An article describes the limited clarity in takaful that has hampered the industry's growth.
  
• Nomura International plc entered into a $50 million commodity murabaha transaction as its debut transaction in Islamic finance.
  
• The Islamic Development Bank is planning to boost cooperation with India, which is not an OIC member.
  

DIFC template for sukuk, Islamic banks in Africa

I am disappointed that it has taken this long, but the DIFC seems poised to provide a standardized template for sukuk based on the recent IFC sukuk. The work has been labeled the "Dubai docs" in reference to the role that the DIFC is playing in providing a standardized set of sukuk documents. Until now, each sukuk has been structured individually and there is no set of documents that creates a standardized offering document so the costs, estimated at $250,000, is borne by each issuer having to build an offering document without a standard reference contract. In other countries like Pakistan, the Central Bank offers standardized contracts for basic products like murabaha and the IIFM has issued a standardized murabaha contract, as well as one for derivatives (tahawwut) with the International Swaps and Derivatives Association (ISDA). I think this will be something that spurs similar documents elsewhere in the world that will reduce the cost of sukuk issuance and encourage new issuers who would have otherwise been deterred by the cost to enter the market. This will, in particular, bring smaller issuers into the market to provide a source for a sukuk yield curve that does not just include sovereign issuers nad high-grade corporate issuers. The more the sukuk market can develop and provide a separate yield curve for sukuk issuers, the more ti will open the market up to other new issuers. The more sukuk that are issued (and especially the diversity in issuer characteristics) will provide alternative investment opportunities to holders of sukuk, which will help the secondary market develop further.

Islamic banks starting in Sub-Saharan Africa face an image problem that they are only catering to Muslims. The Central Bank of Kenya is working on a framework to issue sukuk to attract capital from the Gulf states. The Central Bank governor gave a speech recently at a conference in Nairobi, Kenya along with other representatives of Islamic banks in Kenya and other parts of Africa. The Standard Bank Group is starting to provide Islamic banking products in Tanzania. In addition, recently National Bank of Commerce launched an Islamic banking service.

Other News

• Sukuk is still a niche market and the Nakheel sukuk resolution will not revive the market. Nakheel's 2010 sukuk maturing next week will not revive the market on its own. This is expected to occur even without a restructuring agreement for Dubai World's debts, which HSBC describes as "very fair".
  
• Standard & Poor's rated an Islamic fund, its first such rating. The fund is offered by European Finance House.
  
• Lebanon is not planning to offer a sovereign sukuk. Luxembourg, however, is considering offering a sovereign sukuk.
  
• Another article presents comments on the need for a systemic stability regulator for the Islamic financial industry.
  
• Al Baraka expects to complete the purchase of a stake in Bank Muamalat by the end of the year.
  
• Hawkamah and the American Bar Association organized a conference in Dubai on Islamic finance at the DIFC.
  
• Indonesia's ministry of finance plans to raise 1 trillion rupiah ($110.8 million) in sukuk on May 11. Several recent sukuk auctions have failed recently with investors demanding a higher yield than the ministry of finance is willing to pay.
  
• Several sukuk, including two Nakheel sukuk, have been suspended from NASDAQ Dubai for failure to file financial statements and annual reports.
  
• Cagamas and Al-Rajhi bank are cooperating to issue a sukuk recognized as being in compliance with Shari'ah globally.
  
• Malaysian firm MTD InfraPerdana issued a MYR100 million ($31.2 million sukuk).
  

Nakheel to repay maturing sukuk on May 13, equity vs debt in Islamic finance

An unnamed government spokesman says that Nakheel's sukuk maturing on May 13th even if there is no formal debt agreement according to Bloomberg. Heiko Hesse and Andy Jobst of the IMF provide their own analysis of the Nakheel situation including what I believe is the first analysis of how the issue of Shari'ah-compliance might create issues with the resolution of the company's problems (as described by the conventional thinking about the proposed debt restructuring plan. I have aired my own views in the past on this blog, but unless a Shari'ah board were to weigh in the actual impact of requiring Shari'ah-compliance for a restructuring plan cannot be known.

Kuwait Finance House Malaysia has offered several real estate financing transactions using an equity-based (mudaraba or musharaka) model, while most other banks have not. Shari'ah scholar Aznan Hasan, who I had the pleasure of hearing speak at the recent UFANA conference in Toronto, is quoted in the article saying "Whether it is debt or equity that suits you better, it depends on commercial and business decisions, not syariah matters". I would tend to agree with Aznan Hasan on this, although I my own views on the use of equity versus debt in Islamic finance has gone back and forth during the time I have written this blog.

Other News

• There are concerns over the cash levels to fund coupons and principal repayment of the Villamar sukuk, although the issuer denies there is a cash crunch.
  
• Qatar First Investment Bank raises a number of important challenges facing the Islamic financial industry.
  
• Regardless of the outcome of the UK election, the government will likely continue to encourage Islamic finance by removing barriers that make Islamic finance more difficult and costly compared with conventional finance. The official position as described by the FSA has been 'no obstacles, no special favors'.
  
• A South African private equity firm plans to extend Islamic private equity funds towards black economic empowerment (BEE) projects.
  
• Zurich Financial Services plans to enter into the takaful markets in Saudi Arabia and Malaysia.
  
• Kuwait Finance House, the country's largest Islamic bank, saw its profits fall in the first quarter of 2010 compared to the same period last year. The profits for 2009 were down significantly from 2008.
  
• A writer describes Islamic finance as instructional to provide capital on attractive terms. However, while the article is interesting and the points well made, its description of the industry bears little resemblance to how Islamic finance works in practice.
  

Dubai World, Saad Group

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

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

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

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

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

Other News

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

Dubai World update and more

In contrast with the 1% rate offered to debt holders by Nakheel, the company has offered trade creditors tradable sukuk with a 10% coupon. The distinction, as described in a Reuters article is that it will allow trade creditors to monetize the sukuk at a better price. However, this could also make debt holders reject the restructuring plan. The price trade creditors could receive from selling the sukuk would depend not only on the coupon, but on the perceived ability of Nakheel to make good on its obligations following the approval of the restructuring plan. Local banks are seeking better terms in the Dubai World restructuring plan.

Rushdi Siddiqui writes in Gulf News about the need for Islamic financial institutions to view public relations as an important part of business development to expand their appeal.

Other News

• A contributor to TwoCircles.net describes the potential for Islamic microfinance and laments the shortage of Islamic banks becoming involved with microfinance.
  
• The sukuk market is not expected to regain its growth until 2011-2012 according to analysts. 2010 is expected to be flat compared with 2009, where there was significant recovery after a multi-year low in 2008.
  
• The Saad Group has yet to reach an aggrement with the banks to whom it owes at least $6.5 billion.
  
• Without naming The Investment Dar, Lahem al-Nasser, writes a damning criticism of their challenge in the case surrounding the wakala agreement with Blom Bank in Asharq Alawsat calling their legal claims 'Machiavellian". Andrew Cunningham, the managing director of the Financial Services Volunteer Corps adds his thoughts in a Financial Times opinion piece.
  
• Islamic banks in Malaysia and the UK plan further cooperation to increase the number of cross-border transactions.