South Africa may turn to sukuk to finance infrastructure projects

With a planned $500 to $700 million ijara sukuk to be used to finance infrastructure, South Africa may just be testing the water to finance a part of the billions it foresees in future infrastructure projects directly financed by the government.  If the sukuk offering goes well, the country could become a regular issuer.  The current sukuk however, is no small feat even as the country’s bond yields hover around 12 month lows.  Both S&P and Fitch have downgraded the country within the past 6 months to BBB, two notches above junk.  

Join the ThomsonReuters Islamic Finance Gateway to read the rest of this post.

You will also receive the Daily Briefing and Weekly Wrap newsletters and can join the discussion on this subject in the IFG Morning Wrap on Thursday morning at 9:30am Mecca time (GMT+3). 

Please join the IFG on social media using LinkedIn, Facebook, and Twitter.

 

Shari'ah scholar licensing, IIT sukuk, Islamic indices

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

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

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

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

Other News

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

Islamic foreign exchange forward contracts; halal participation banking?

Malaysian scholar Shamsiah Mohamad, who is a member of the Securities Commission Shariah Advisory Council, said that muwa'adah is a valid contract for foreign exchange contracts. Muwa'adah is a mutual promise in forward foreign exchange contracts and has been ruled impremissible by AAOIFI. The trading of currencies in forward markets is viewed as prohibited because currencies (taking the analogy from trading of gold and silver, which were used as dinar and dirham coins) must be traded only in the spot market. The distinction made with muwa'adah by the scholar is that the forward trade is a promise, not a contract because "it is not a sale and purchase contract because specific words must be used to enter into a contract in Islam". The controversy emerges because AAOIFI has ruled that the transaction (the binding mutual promises) does represent a contract and therefore cannot be used for foreign exchange futures contracts. It is one more example that the fiqh surrounding financial matters is still evolving in many areas and--whether it leads to positive or negative outcomes for the industry--it does represent an area of uncertainty in Islamic finance.

Rushdi Siddiqui's latest article in Gulf News deals with whether Islamic banking needs a rebranding. I have heard him speak a number of times and he has articulated the need to move beyond the 'Islamic' brand and the use of Arabic names for contracts to become more 'familiar' or 'accessible'. In his article, he ends with a combination of two ideas for Islamic banking: 'Halal Participation Banking', which combines the idea of that which is halal (which has been successful in the food industry) with participation banking, the name for Islamic banking in Turkey. I think it will be difficult to change the description of Islamic banking as 'Islamic', but that should not deter anyone from trying. In particular, the use of "participation" as a descriptor of the Islamic banking system is a good one in my opinion because it represents a reminder that Islamic banking differentiates itself as one where 'risk sharing' is an important idea. It may be used in practice less often as many Islamic financial products have replicated conventional financial products, but it provides a more clear explanation of how Islamic finance is designed to differ from conventional finance. It is also a phrase which can more easily convey the difference (in theory) with conventional finance and can be more easily be grasped by non-Muslims who may agree with the ideas of Islamic finance without even realizing it because of the use of Arabic terms and the 'Islamic' or 'Shari'ah-compliant' label.

Other News

• South Africa has a proposal to modify its tax laws to place Islamic finance on equal footing with conventional footing by treating the profits in Islamic finance in a way equivalent with its treatment of interest in conventional transactions.
  
• The latest Central Bank of Bahrain Sukuk al-Ijara was oversubscribed 630% with BD63 million in subscriptions received for the BD10 million ($26.5 million) issue.
  
• Abu Dhabi Commercial Bank issued the first sukuk in its RM3.5 billion ($1.1 billion) sukuk program for RM500 million at 4.75%.
  
• Bloomberg has an article about the IIFM report on Islamic repos, which I discussed after it was released.
  
• An article describes the potential of Islamic finance in Russia and adds that state-controlled VTB Bank, which has had a sukuk in the pipeline for several years, will issue its sukuk for $200 million in the second half of the year, citing a Reuters report from April.
  
• Dubai's oldest Islamic bank, Dubai Islamic Bank, reported lower income in its second quarter financial report. It did not reveal its exposure to Dubai World. DIB owns 20% of Tamweel, the troubled Islamic mortgage company, and Deyaar, a Dubai-based property developer. Tamweel, which is in merger talks with Amlak Finance, another Islamic mortgage company in Dubai, reported positive income for the most recent quarter.
  
• A takaful provider, Dar Altakaful, launched a takaful policy for horse owners if their animal dies or becomes injured.
  
• An article in Bloomberg discusses the growth of Islamic investing in Malaysia with the entrant recently of international companies like Saturna Capital, the parent company of the Amana Funds in the U.S.
  
• Gulf Finance House is planning to raise additional capital--the second time in less than a year--and has delayed reporting its results.
  
• Ithmaar Bank reported its first results as an Islamic retail bank since its reorganization with its former subsidiary Shamil Bank.
  
• Bahrain Financial Harbour Holding Company repaid a $134 million sukuk.
  

Islamic retail banking in the West: Can the US provide an example?

There are a number of articles about the challenges facing the Islamic finance industry that caught my eye in the last couple days but none challenge the conventional wisdom as much as an article from Bloomberg that Islamic banks or conventional banks Islamic windows in the UK have been set back substantially by the recession. Further, there may be too many banks (22) chasing too small a market ($19 billion versus $93 billion in Malaysia). Another article in the Independent focuses on the withdrawal or shrinkage of retail Islamic finance at large banks in the UK. One of the areas where the Bloomberg article flies in the face of conventional wisdom is that the UK government has not supported the Islamic financial industry sufficiently. This contradicts the widely held view that the UK is preeminent among non-Muslim-majority regions in both its level of development and the scope of government support. As much as this challenges these ideas, there is a caveat that is not mentioned in the article: it is mostly focused on the domestic market, not the participation of UK-based banks in the global Islamic finance industry. However, it does set back the idea that Islamic banking can become a widely accepted subset of the domestic financial industry in non-Muslim-majority countries with sizeable Muslim minorities.

On the scale that Bloomberg is looking, there probably is not a large enough market that can easily be penetrated by large institutions and the one solely retail focused and Shari'ah-compliant institution, the Islamic Bank of Britain represents too small a sample to generalize about the prospects for smaller institutions. In this regard, the United States may provide an example of how Islamic banking can be feasible without participation from large conventional banks. The US market--for reasons of regulation and geographical concentration of the Muslim population--has no product availability among the large banks, but under the radar exist community banks, credit unions and non-bank financial companies that provide Islamic financial services. This may be the maximum size that is profitable currently in countries without sizable Muslim populations and that should be recognized as a success. Although the headlines are drawn by the largest and the newest products and institutions, having financial institutions that recognize the value of remaining small enough to serve their customers and avoid overexpansion is a virtue in itself. Not all areas in the U.S. have remained under the radar. For example, the Amana mutual funds have grown over the past decade and two of the funds are the largest Islamic equity funds in the world, in large part because they have transcended their natural market and attracted non-Muslims based on their performance.

Areas of the Islamic financial industry that are not yet able to attract significant non-Muslim participation but are able to avoid growth-at-any cost may not make the headlines, but the experience of the Amana Funds shows that this is not necessarily a failure. The Amana Funds remained small for many years before starting their rapid growth at the beginning of the last decade. Their growth was "supply-driven"; it was "demand-driven" based on their ability to provide a service demanded by consumers both Muslim and non-Muslim based on its performance. There cannot be a direct analogy that could work elsewhere in non-Muslim majority countries, but the contrast could provide lessons for other non-Muslim-majority countries with aspirations to develop a domestic Islamic finance market. Maybe the next decade will be the decade for retail banking.

Other News

• Rushdi Siddiqui has two great articles in Gulf News. In one article he suggests: "For Islamic finance, a lack of Muslim inclusion should be a greater concern than lack of standardisation. When we speak of convergence, it may well entail technology (mobile phone) and banking for the non-bankable Muslims. Hello, is Islamic finance listening at the other end?". In the other, he interviews Dr. Mohammad Nedal Al Chaar, the Secretary-General of AAOIFI.
  
• As the Islamic finance industry grows in Canada, the Rotman School of Management at the University of Toronto is the first to offer a course on the subject for MBA students.
  
• Saudi Binladin Group sold a short-term sukuk with a maturity of 9 months for $187 million (SAR700 million). Most sukuk have a tenor between 3 and 7 years.
  
• Sukuk sales in 2010 are expected to be $23-$25 billion according to a poll by Reuters. This was close to the $23.3 billion issued last year and lower than a poll conducted in April which forecasted $28 billion in sukuk sales. Asa Fitch wrote a good article in The National about the growth of the sukuk market and the rapid decline during and after the financial crisis.
  
• Even after a four-month rally, the yields on Nakheel's sukuk are twice as high as 2007. A credit analyst at S&P in Paris, Mohamed Damak who also is co-chair of the Islamic finance working group for S&P points to this as evidence that the market is still hard to access for real-estate-based companies.
  
• Kazakhstan has resumed planning for its first sukuk, which is not expected soon and will likely be an ijara sukuk of roughly $300 million. There are a number of regulatory issues that need to be dealt with.
  
• Russian bank Vneshtorgbank (VTB) has also resumed work on a sukuk issuance and "a range of other Islamic financial products". The Association of Regional Banks of Russia established a task force on Islamic financial institutions.
  
• An article in Arab News describes the backlash facing Islamic banks in South Africa over high fees. However, the criticism of the high fees are not limited to Islamic banks.
  
• A report about Islamic banking in Indonesia was released recently.
  
• The Saudi Electric Company is planning a fourth sukuk. The timing, size and pricing are yet to be determined.
  
• Abu Dhabi Ports Company is considering a bond or sukuk of up to $1 billion in early 2011.
  
• Bermuda is trying to attract the Islamic finance industry following a trip by the CEO of the Bermuda Stock Exchange to Bahrain.
  
• An opinion piece in China Daily by the program director of the University of Hong Kong SPACE on the development of Islamic finance in Hong Kong, including the areas where it is being held back, particularly in human capital.
  

Future growth in Islamic finance, sukuk news

Future growth in Islamic finance
An article in the National newspaper provides a good summary of the growth areas in Islamic finance, as well as the areas of controversy which remain in these areas. The largest focus is on whether creating Shari'ah-compliant hedging contracts is a help or hindrance for the growth of the industry. In some aspects I can see how it reinforces the view that Islamic finance does nothing but mimic conventional financial products. However, as the article notes, longer term financing like what would be necessary for project finance, would be largely absent were there not a way to hedge against currency, commodity price or interest rate fluctuations.

The article also discusses the lack of Islamic microfinance. Moinuddin Malim, the CEO of Mashreq Al Islami, is quoted as saying "We have not yet reached our real audience. We need to develop microfiannce to enable communities to thrive in their own right and bring living standards to them". I would disagree with his characterization of "bringing living standards to them" and replace that with bring affordable, Shari'ah-compliant financial alternatives, but it is definitely an underserved area of Islamic finance. The CGAP competition which recently closed (and I advised two groups who submitted proposals) is a good effort because it focuses on providing seed money to develop sustainable financial institutions (either non-profit or for-profit). However, outside of this and a few efforts by a couple small efforts by (mostly) global financial institutions in Islamic finance, there has been not much more than lip service paid to the need for Islamic microfinance.

There is a lot more to Islamic finance than just structured products that mimic conventional finance for large corporations and sovereigns. Islamic retail banking fills some of the need with a reach towards a larger number of Muslim consumers, but there are many Muslim (and non-Muslim) 'unbanked'. This is the consumer base that the Grameen Bank was formed to serve and it has now attracted a lot of attention from larger financial institutions. The same need is present for the Islamic financial industry to fill and it should be a quicker transition for Islamic financial institutions to recognize this need (and potential) now that conventional microfinance is well established with participation from the larger financial institutions. It is also ideally suited to the underlying ethics behind Islamic finance, which should feel a greater need to promote economic empowerment based on its ethical foundations.

Another article describes the re-emergence of innovation within the Islamic financial industry which has largely been absent during the recession. There are areas--like liquidity management--where innovation can be a positive development to increase the available investment opportunities (particularly short-term and overnight). However, there are also a lot of 'innovations' during the 2005-2008 period in structured products and especially real estate, where 'innovation' can turn into 'high fees with little other benefit'. One example of this that has been described in detail was Gulf Finance House, which was described in a recent paper by Mohammed Khnifer.

The issue of standardization remains contentious. The debate, however, depends on what standardization means, which Debshis Day of Clifford Chance pointed out, is unclear. "Standardization, what does that really mean? It is very difficult for everybody to agree on one thing. People need to understand that even in a conventional market there is not pure standardization". I would agree with him that complete standardization is neither possible nor probably desirable. There are certain areas (like the ISDA-IIFM derivatives standard and the IIFM standardized murabaha agreement) where standardization can be beneficial by reducing costs associated with replicating the same structure. However, these standardized contracts are not, nor should be, mandatory. There are numerous areas where improvements can be made and leaving the door open to new products or new variations of existing products makes sense for the industry as a whole.

Sukuk News
Unicorn Investment Bank and Standard Chartered report they have mandates to work on issuance of $6 billion in sukuk this year. Reportedly, over $4 billion of this amount will be advised by Standard Chartered. An executive at HSBC, Mohammed Dawood, says that issuance of dollar-denominated sukuk may reach $5 billion, matching the previous year's total. The total issuance may be $8.5 billion, about last year's level, but far below the pre-crisis levels in 2007 and 2008. However, due to the Greek crisis and Ramadan, most issuance will be pushed into the third quarter. Al Rajhi Bank, which has been largely absent from the sukuk market due to concerns by its Shari'ah board over the compliance of the sukuk in the markets, plans to launch a sukuk with Cagamas, the Malaysian housing finance agency, in June. Indonesia recently sold $467.5 million in sukuk to the government-managed Hajj fund.

U.S. issuers could make up part of the issuance in the second half of this year or in 2011. GE Capital, which issued a $500 million sukuk last year (my summary of that sukuk) is planning a 'benchmark' sized sukuk in late 2010 or 2011, which is generally over $500 million. In addition, Unicorn Investment Bank, which has a U.S.-based private equity subsidiary UIB Capital, is working on a $250 million sukuk for a U.S.-based company. The only two sukuk issued by U.S.-based companies so far have been the East Cameron sukuk, which ended with investors owning the underlying asset after the issuer entered bankruptcy, and the 2009 GE Capital sukuk.

Another rare issuer coming to market is Malaysia, which will likely offer its first international sukuk since 2002. The sukuk, expected to be an ijara sukuk with a 5-year tenor is said to be backed by government hospital assets. The issue is reported to be a $1 billion, however, it has not been formally announced and is expected to be announced at an Islamic economic forum in Kuala Lumpur.

Robin Amlot writes an interesting review of an e-book published by Euromoney, written by Parvez Daruwalla and Shahzad Siddiqui, in Islamic Business & Finance. The e-book talks about whether the sukuk structure, and in particular sovereign sukuk, could be done better.

Article by the CEO of Gatehouse Bank

Richard Thomas, the CEO of Gatehouse Bank, an Islamic wholesale bank in the UK, has an article about Islamic finance. While in general, he speaks to the general outlook for Islamic finance globally, he makes two notable points. First, he does not fall into the "Islamic finance is immune from the crisis" trap and secondly, he acknowledges the overlap between Islamic finance and ethical/sustainable finance. He writes:

"Islamic finance has, however, been met with enormous challenges. It has not escaped the global downturn despite Islamic banks being safeguarded by the nature of their Shariah principles against exposure to subprime mortgages and the other toxic assets that have hurt the balance sheets of so many of the world’s biggest financial institutions. "
[...]
As it is, a substantial amount of business transacted in an ethical or sustainable format may qualify as Sharia compliant. This demand for products and investments, while primarily fuelled by the world’s 1.3 billion Muslims, is supporting interesting crossover products that benefit from the same ethical criteria."

Other News

• Golden Belt Sukuk holders approved the dissolution of the sukuk trust, making the sukuk holders unsecured creditors of Saad Group.
  
• The Central Bank of Bahrain's sukuk al-ijara issue was oversubscribed by 230%. The sukuk has a maturity of 182 days.
  
• Dana Gas reset the conversion rate on its sukuk according to JPMorgan Chase & Co., the calculation agent.
  
• South African investment management firm is planning on launching its products outside of its home country including within Europe.
  
• Aston Business School will launch an MSc and PhD program in Islamic banking with sponsorship from the CEO of Dubai-based Surgi Tech.
  
• Al Rajhi Steel Industries, a Saudi rebar manufacturer obtained a $196.5 billion Shari'ah-compliant bank loan to finance construction of a new plant in Jeddah.
  
• The Iraqi bank Ashur Bank is exploring offering an Islamic banking window, for which it submitted an application six months ago to the Central Bank of Iraq. 7 of Iraq's 42 banks are Islamic banks.
  

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.
  

Sukuk and Dubai World/GFH, innovation in Islamic finance, sukuk investor relations

It is "incredibly unlikely" that the Nakheel sukuk due on May 13th will be repaid according to an anonymous source quoted by Reuters. Dubai World is still negotiating with its creditors to deal with its debts and the Dubai Financial Support Fund, which has lent money to keep Dubai World entities operating has signaled its intention to give up its senior status as a concession to other creditors. Another source speaking to Reuters said that "it is fully expected the banks will say they don't like it" but the source also described the plan as being "very very fair". The problems with Dubai World and other sukuk issuers will lead to the issuance remaining weak this year according to Hussein Hassan. The head of Deloitte's Islamic Finance Knowledge Centre says that the troubles with Gulf Finance House who recently extended part of a sukuk issue that was maturing are "not sign of weakness in Islamic finance".

A Finance professor at the American University of Sharjah described Islamic banks compared to conventional banks' performance and efficiency:

"Islamic banks are less cost efficient and more profitable than conventional banks, but their profit efficiency is slightly lower. The differences in profit efficiency can be attributed to lower cost efficiency. Islamic banks have been more successful than conventional banks in terms of revenue efficiency and accounting profitability, but both Islamic and conventional banks in the region need to become more profit efficient"

The 9th annual Islamic Finance Summit, which was held in London discussed the opportunities that Islamic finance has, as well as some it has missed in the financial crisis. One interesting warning came from Mohamad Nedal Alchaar, secretary general of AAOIFI, who said "mimicking is a dangerous business and would strip our uniqueness". This comment followed another participant who said that Islamic finance needs greater product innovation.

It is a tricky balance between meeting the financial needs of the customers of Islamic financial institutions and remaining distinct from the conventional financial industry. There are benefits to making products, even some derivatives, available in Shari'ah-compliant forms because they can provide valuable opportunities for businesses to hedge some risk not directly connected with their primary business (currency/interest rate/commodity price fluctuations). However, in my opinion, the best way to look at innovation and determine whether it's valuable is not necessarily to determine whether it is 'different' from conventional financial products, but whether it receives approval from a Shari'ah board and which meets a need beyond generating income for the financial institution structuring it. One thing that would be useful for the industry as a whole (although it could be difficult to convince each bank to support) would be for there to be a publicly available, central database of fatwa that describe the thought process of the Shari'ah scholars in reaching their conclusion about the compliance of a given product. This would be difficult to accomplish in practice, especially for new products, because it would allow other institutions to potentially take new structures and copy them without bearing the cost of their development.

Frank Kane wrote an interesting article about the impact of the financial crisis on Islamic finance. He makes an important point: "the tangibility of assets under a Sharia-compliant system did nothing to halt the decline in asset values that spread inexorably from the West to the Gulf". In addition, he quotes a Bank of New York Mellon report on sukuk investor relations (IR): "The adoption of sukuk IR can improve the quality of due diligence, foster an open dialogue between stakeholders and contribute to an ongoing process of disclosure beyond what is nominally contained in a prospectus".

Other News

• Arcapita reported a loss in the quarter ending December 31, 2009 on lower placement fees and asset valuations.
  
• BPA Malaysia signed an agreement to provide information on ringgit-denominated sukuk data to Thomson Reuters' new Islamic Finance Gateway.
  
• Gulf-based investors are expected to approach South African authorities to launch an Islamic investment bank with capital of $1 billion.
  
• The resumption of trading in Tamweel, which the company will request, is separate from its merger with Amlak Finance and there remain many issues that need to be resolved.
  
• The Brunei Times has an interview with Dr. Mohamed Sharif Bashir, the dean of Faculty of Business and Management Science at the Sultan Sharif Ali Islamic University in Brunei.
  

Sukuk issuer quality, M&A, JAFZ downgraded

One of the areas of the Islamic finance industry that has been noticeable recently is the dearth of sukuk from non-high-quality issuers. This is particularly noteworthy in the GCC where a large supply of sovereign issues has not been followed by a comparable level of corporate issues. This trend was noted at a conference in Malaysia. The reasons commonly cited focus mostly on the pricing of sukuk and many even from sovereign issuers have priced considerably higher than they did prior to the financial crisis. With a pipeline of sukuk estimated to be $45 billion, a real recovery in the sukuk market should not be measured by the aggregate value of all sukuk, but by the ratio of sovereign versus corporate issuers.

Another area where the Islamic finance industry has yet to see much activity is in merger and acquisition activity between Islamic financial institutions. This is due to several factors, described well in the Yasaar Media Islamic Investment Banking 2009 report I summarized recently, but according to most industry participants there are simply too many Islamic banks and a majority of them are small. M&A activity could expand Islamic banks' balance sheets which would enable them to provide financing to more big projects as well as achieve greater diversification. in this light, it is noteworthy that Malaysian-based Bank Islam is reported to be 'actively seeking' a merger partner.

Jebel Ali Free Zone was downgraded by Moody's over concern about what support the Dubai government will provide to government-related entities. Jebel Ali Free Zone is a part of Dubai World. The downgrade puts a new light on the issue of valuation or illiquidity for the JAFZ Sukuk when looking at secondary market prices. Back in early February, I wrote a blog post on my blog at Zawya when the secondary market price was 66 . While the price has rebounded some to 77, that is still well below par and suggests that some price discovery may have been in fact occuring in sukuk secondary markets.

Other News

• Dow Jones Islamic Market Indexes named Tariq Al-Rifai, the founder of Failaka Advisors, to head its Islamic Index family following the departure of Rushdi Siddiqui last year to head Reuters' Islamic finance division.
  
• Gatehouse Bank combined two business units--its asset management and capital markets divisions--in the UK under new management to 'create an even stronger business' according to a company press release.
  
• Mayfair Wealth Management launched a Shari'ah-compliant UAE-focused distressed property fund and hope to raise $50 million.
  
• A UAE-based law firm Agha & Shamshi became likely the first Shari'ah-compliant law firm.
  
• South African fund manager has run into problems launching its planned Islamic equity funds, following the departure of its sole Islamic fund manager who remains as an external manager of their sole Islamic equity fund.
  

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.
  

Ijara sukuk; Islamic finance hurt by falling asset prices; KFH-Turkey to open branch in Germany; GCC banks convert gov't deposits into capital

The announcement that ijara sukuk were the most common form of sukuk in 2008 came from a Moody's report that attributed its popularity to the AAOIFI ruling in February that criticized the Shari'ah-compliance of other forms of sukuk. Although I have argued that the AAOIFI ruling did not cause much of the overall reduction in sukuk issuance in 2008 (the evidence suggests it had more to do with the credit crisis), the shift in types of sukuk is more likely to be affected by AAOIFI rulings. Placing AAOIFI in the center of the decision around which types of sukuk are optimal is the right thing to do. There are many types of sukuk approved by AAOIFI and it benefits the industry for AAOIFI to direct which forms of sukuk are optimal from a Shari'ah-compliance perspective. However, more transparency from the organization reduce the uncertainty that contributed to significant confusion about which forms of sukuk were preferred by Shari'ah scholars that prevailed between Sheikh Usmani's comments in November 2007 and the AAOIFI clarification in February 2008.

An article that provides an introductory look at the Islamic financial industry provides a few good points that are not frequently expressed explicitly about the susceptibility of the Islamic finance industry to falling asset prices.

"However, in spite of these facts, following Islamic principles is not enough for banks to get the total protection from the financial crisis. Islamic finance is so intertwined with the global financial system that they also can’t avoid problems.

Many Islamic banks have invested their funds in equity. When the prices for real estate go down, their portfolios also go down. Countries involved in computer and electronics manufacturing (such as Malaysia) have been hit by competitive devaluation and reduce of export.

So even though Islamic countries have not suffered from the credit crunch, they have suffered from asset valuations and its financial effect.

Kuwait Turkish Participation Bank (KFH-Turkey) received approval to open a branch in Germany. The entrance into the European Union through Germany is a first. Prior to this announcement, Islamic banks wanting to enter into the EU started in the UK because of the FSA's accommodative stance towards Islamic financial institutions and the legal and regulatory changes which places Islamic finance on equal footing with conventional financial institutions.

Many Islamic banks in the GCC are converting government deposits into Tier 2 capital in order to strengthen their capital position. The two most recent banks to convert are Emirates Islamic and Abu Dhabi Commercial Bank.

Other News

• Russian bank VTB may become the first Russian company to raise funds using a sukuk.
  
• There is an interview with the CEO of the only Islamic bank in South Africa.
  
• A Russian mufti calls for increased use of Islamic finance.
  
• An article describes how the new Shari'ah-compliant gold ETC is monitored from a Shari'ah-compliance perspective, including unannounced reviews.
  
• The decision about whether or not to merge Amlak and Tamweel, Dubai's struggling Shari'ah-compliant mortgage providers is in the final stages and liquidation of the two institutions is not being considered. Tamweel announced that it had not seen an increase in the numbers of foreclosures despite deteriorating economic conditions.
  
• The IFSB summit that will be held in Singapore will focus on whether the current structure of the Islamic financial services industry will need to change as the industry matures and grows.
  
• Zawya Dow Jones interviewed the CEO of the Asian Finance Bank.
  
• The president of the Islamic Development Bank is interviewed before a conference in Kazakhstan. The president, in a different interview, said that the bank is planning to issue a $500 million sukuk in the next few months.
  
• The head of Kuwait Finance House (Malaysia) says that assets in Islamic funds will decline in the near term but grow over the longer term. He also said that the global economic crisis will lead to more local currency sukuk instead of being issued in dollars.
  
• Global Investment House released a report on Bahrain's Islamic finance industry and said it expects the industry to rebound in 2009. During 2008, the volume of sukuk issuance fell to $700 million from $1 billion in 2007.