How can Islamic finance absorb the human capital from Islamic finance training programs

The Islamic Globe has had quite a few article exploring the dichotomy between the stated need for more employees with the difficulty that Islamic finance graduates have in finding employment once they complete their studies.  I have had a number of emails from Islamic finance graduates looking for advice on getting a foot in the door of the Islamic finance industry and I don't have much advice, so the Globe's articles are illuminating, looking at the issue from the perspective of the industry, educators, and students and graduates.

Another data point is from the industry that is facing rising costs (with Malaysia as an example) from the lack of 'skilled' employees.  The article I linked to suggests that Islamic banks in Malaysia should look to consolidate to cut down on their operating expenses.  The CEO of Bank Muamalat says: "Costs have risen easily by 20% to 30% mainly due to the shortage of human capital and increased regulatory costs. Margins are falling and the only way to counteract this is to become bigger and more efficient".

What I understand from the Islamic Globe's reporting is that the types of skills the Islamic finance training programs provide are not enough focused on the actual application of Islamic finance, but are instead more focused on the background of what Islamic finance is in theory.  However, I suspect my description is an oversimplification and Islamic finance training programs do provide some real-world training on the practice of banking.  But still, without experience in actually doing the job, many people in training programs will still need additional time to get up to speed in a new job compared to bankers from the conventional industry switching to Islamic finance.  

This is problematic because many people who have contacted me are reticent to enter the conventional financial industry because it is interest-based, and must rely upon the training they receive to prepare them for a career in Islamic finance.  This will continue the trend of Islamic finance graduates having difficulty breaking into the Islamic finance industry, which would be disappointing since they could be a big asset to Islamic finance with their enthusiasm for helping the Islamic finance industry develop and become more 'authentic'.  

This loss will not show up now, or even in the next 5 years, but will have a longer-term detrimental impact on the economy.  The best approach I think is to continue to develop the industry's training programs, as well as the academic departments focused on Islamic finance, but also to add more internships and other forms of on-the-job training.  If students are able to get experience while they are in school, they will be better able to enter the market with more skills (and connections) that will make it more likely that they will find a job when they graduate.  This is, by and large, how conventional finance works.  And it should be developed further in Islamic finance.  

Perhaps, one of the ways this can be accomplished is if there is an endowment funded that will provide companies with funding for paid internships for students in Islamic finance programs, to provide students with the financial ability to take the internships that Islamic financial institutions may not otherwise provide if they had to offer a paid internship.  Maybe this will only be necessary for a period of time until the consolidation that has been advised for years comes to pass and the Islamic banks reach a scale where they have the internal resources to support their own paid internship programs.  

Tawarruq

There are almost as many opinions on tawarruq as there are people who know what the term means. With questions being raised about whether a recently launched Goldman Sachs murabaha sukuk was a tawarruq or not, the issue has been thrust into the forefront of discussions within Islamic finance*. A discussion of some of these issues are available from Camille Paldi (posted as a PDF).

This article had a link to a page from ISRA, which listed a number of different fatawa from different Shari'ah boards about the permissibility of, and structure of, tawarruq transactions. I, of course, cannot say whether a tawarruq is permissible or not. However, reading Paldi's article, and the Shari'ah opinions about tawarruq, there are some points which I find noteworthy about tawarruq.

The basic structure of a tawarruq (as used in the financial industry) is that the bank will buy a commodity (e.g. nickel from the London Metal Exchange). Once ownership transfers to the bank, it will resell the metal the the customer for the price paid, plus a profit, with repayment either in installments or as a lump sum. In either case, repayment will occur in the future. The customer then takes ownership of the metal and sells it to a metal broker to get cash.

In terms of economic outcome, neither party owns the metal, but the customer has X dollars in cash, with an obligation to repay the bank X + p dollars (p is the profit). In this example, the bank and the client can be switched for a tawarruq-based deposit product. During the entire transaction, the only time the metal involved makes an appearance is in the initial purchases and sales. One fatwa said: "It is compulsory to base this practice on the purchase of assets, which are then sold to the party who desires financing, i.e. the customer. The customer will then sell it to another party at a price that is agreeable to both parties. The delivery and payment is concluded on the spot".

When the final sale is completed, another fatwa reads: "One of the conditions of a legitimate tawarruq contract is that the bank must not guarantee the customer a specified price in the market but sell the goods at the best price, in accordance with the forces of supply and demand at the time of sale." One of the issues raised by multiple fatawa was avoiding instances where the bank (or its broker) is both selling to the bank and buying back. 




These Shari'ah issues are interesting--I cannot offer an opinion about what they mean for the Shari'ah-compliance of any individual product--but they do raise a few issues on the financial side (e.g. if one were looking at the way transactions were actually carried out).  First, the basis of the organized tawarruq product relies to some degree on ensuring that the price paid for the commodity is equal to the price at which it can be sold.  The commodity markets on which these tawarruq transactions are based can be volatile, even on an intra-day basis, so an Islamic bank acting on its own behalf to buy the metals and later as agent for the customer to sell them, is exposed to the risk that the price of the commodity rises or falls.

Theoretically, I assume that the bank is supposed to pass that price risk on to the customer, who owns the metals between the initial purchase and the final sale.  However, many customers, particularly retail customers, will not want to assume the price risk of the underlying commodity.  There may even be regulations that limit the ability of the bank to change the effective profit rate after the contract is signed (the effective rate would change if the markup is fixed and the price realized is different than the original cost of the metals; if the price fell, the rate would increase while if the price rises, the rate would decrease).  Yet, the bank cannot guarantee the price realized on the sale of the commodities lest it become both the seller and the buyer (as an intermediary). 

Besides the operational issues with tawarruq, there are more theoretical arguments about its use.  Initially, tawarruq was used for short-term inter-bank financing, where there was no other alternative available (there still are only a few, which was the rationale for forming the International Islamic Liquidity Management Corp.).  Then the product became a consumer financing product.   Now it is being used to structure deposits.  The theoretical question is whether tawarruq ties the hands of Islamic banks to structures that (at slightly higher cost) replicate conventional banks. 

I am generally in favor of Islamic banks using products that meet a banking need from Muslims who would not otherwise engage in the financial system.  I think that makes sense.  However, I also believe that creating an exact replication of the conventional financial system, or even the banking system, albeit with more transaction costs, is not the best goal for Islamic banking.  There is a middle ground between making products available to meet consumer need and turning the entire exercise into a problem-solving exercise for clever bankers and lawyers. 

There is, I think, a valid place for tawarruq in the development of Islamic banking.  It is a useful tool where other tools are not yet designed.  For example, there are few products available for education financing from Islamic banks and the benefit from providing this type of financing to people who will not use interest-based financing is high, both for the individuals and for society as a whole.  This is the proper role of organized tawarruq (in my opinion) within Islamic banking.  It is a fine tool, but Islamic bankers should not let tawarruq be the only tool (as the expression goes, when all you have is a hammer, everything looks like a nail).




* I wrote an article on the sukuk for The Islamic Globe, which was followed by a critical article about the sukuk program, which was followed by another critical article with a rebuttal by the firm which provided Shari'ah consulting services to GS.

Islamic finance education

Last week's newsletter (signup on the left side of the screen) was about Islamic finance education--specifically an article by Mohammed Khnifer about the challenges facing the recent graduates of Islamic finance education programs. 

Mohammed Khnifer wrote an article (the second in a series) that paints a disturbing picture of the job market for graduates, even as the speakers at conferences say there is a huge talent shortage in the industry as a whole. It suggests that either there is a disconnect between the skills that Islamic financial institutions want and what these programs provide, or there is not actually a shortage in the less experienced jobs available from Islamic financial institutions, and the shortage is at higher levels in management.

Neither is promising for Islamic finance graduates, but the former is more easily fixable than the latter. However, if the Islamic finance programs are in fact not offering training in the skills in demand (for which they are charging significant tuition), then a cynic would conclude that they only are involved to capture a 'hot' area of education in demand and do not have their student's best interests at heart.

I don't which one is the case, but it is in some ways a reflection of how the industry works. Most of the students or aspiring students I have talked to or received emails from are younger, less experienced people--many who recently finished their undergraduate studies--who want to work in the Islamic finance industry, but don't know how to get a foot in the door and view specialized Islamic finance training as a way to do that. However, the way the industry works, with a focus on replication of conventional financial products, this is not likely to be an easy way to break into the industry.

A far easier track is there for people with conventional financial experience who want to move horizontally within a firm or from one firm to another. Their familiarity with how financial institutions work from first hand experience makes them more appealing than someone with less experience but more training. This presents a dilemma for some people who don't want to work for conventional financial institutions because there is no substitute for the experience it provides. By recruiting people largely from within the conventional financial industry, at all levels, there will also be more likelihood that Islamic finance continues to operate in the same way it has for the past several decades and make significant changes to the mix between different products, and business models.
 
This is the innovation that, if done gradually to avoid disruptions and with enough care to avoid adding too much risk to the industry, will make Islamic finance evolve in a different way than conventional finance. It will strengthen the industry while at the same time providing a clearer distinction between Islamic and conventional finance. However, without providing an opportunity for younger financial professionals who are not already traveling down the well worn ruts of conventional finance, this innovation will be slowed.

Guest Post: Where to Study Islamic Finance

With the explosion of Islamic banking trends worldwide and with the practices making the news in major markets, more and more people want to know all they can about the field. I usually tell them that one of the best ways to learn about Islamic finance is to take an online course or seek out a nearby university. There are many distance learning options available for students and professionals who want to deepen their knowledge of Islamic banking, as well as classes at established schools, and they're offered through a growing number of quality outlets. Here are just a few to get you on your way.

Institute of Islamic Banking and Finance. The IIBI, based in London, offers a variety of courses at multiple levels, whether you want to study takaful or Islamic banking and insurance.

AIMS. Another U.K.-based organization, the Institute of Islamic Finance features several academic programs: MBA in Islamic banking, Islamic finance expert, certified Islamic banker, and certified takaful professional. As always, make sure that any courses you take are going to be recognized by future employers as worthy and accredited.

Islamic Legal Studies Program. Harvard Law School's ILSP is a fantastic resource for students looking to enhance their knowledge of Islamic law and see how it applies to finance and a number of other professional fields.

BIBF. The Bahrain Institute for Banking and Finance offers an advanced diploma in Islamic finance. The course offerings are split into six modules: Islamic commercial jurisprudence; introduction to trust, banking, and business laws; Islamic insurance (takaful); Islamic treasury, capital markets and risk management; Islamic banking operations; and Islamic accounting standards. Contact the school for more info.

Institute for Middle East Studies. The IMES at The George Washington University offers several fantastic courses on international finance and law, which are helpful for those looking to become well-versed in Islamic finance.

Euclid. Euclid University's online business school offers a distance-learning MBA in Islamic finance designed to build a student's math and banking knowledge while deepening their understanding of the tenets of Islam and how they apply to just financial practices.

Again, make sure that any course you take has been checked out and accredited and will be respected by your employers. Good luck!

This guest post is contributed by Jena Ellis, who writes on the topics of Online Certificate Courses. She welcomes your questions and comments at: jena.ellis20@gmail.com.

Ed. Note: The views expressed in this post are the author's own and not those of Sharing Risk.

Are sukuk prospectuses too complex, other product needs in Islamic finance, possible Dubai sovereign sukuk

The head of the Islamic Financial Services Board, which is based in Malaysia, says that there should be greater investor protection in Dubai and other regional financial centers. Rifaat Abdel Karim, the IFSB's secretary general, pointed specifically to the uncertainty over the ability of investors to have recourse to the underlying asset citing the "200 pages of documents, which most investors don't [read]". While the complexity of sukuk and the dichotomy between asset-based and asset backed structures could provide some confusion, most sukuk prospectuses that I have read clearly delineate whether the investors have recourse on the underlying assets (versus being unsecured creditors in a default). It is incumbent, I believe, that investors use the information presented in the documentation to make an informed decision about whether the risk-reward relationship is acceptable. The head of Islamic finance at Simmons & Simmons, Muneer Khan, said in an interview quoted by Emirates Business 24/7 that the sukuk defaults were "not a Shariah issue" and that the investors had legal and financial advice sufficient to distinguished between secured and non-secured deals adding that "I think some of the claims have been a bit disingenuous".

There are other issues that have more bearing on whether sukuk will work out well in cases of default like the legal environment where the assets are located that are equally as important and less certain than the structure of the sukuk. If there are material misstatements in the prospectuses, that is a different matter, and greater investor protection for this possibility are definitely needed.

The IFSB held a seminar last week on sukuk market prospects in London, on which Mushtak Parker provides an interesting overview. Many of the issues I have raised (and others have as well) were covered in the seminar. CIMB-Principal Islamic Asset Managemenet Bhd recently said that the issuance of sukuk has failed to keep pace with industry growth. Other areas of Islamic finance like money markets and a more diversified asset base for Islamic financial products are needed according to a different article discussing the World Islamic Banking Forum Asia, which quoted the central bank heads of Bahrain and the UAE as well as Islamic financial industry practitioners. The heads of those two central banks called for greater reform within the Islamic finance industry including a "standard formula to calculate profit in an equitable and fair way at all Islamic Banks". At the same WIBC conference, the UAE central bank governor Sultan Bin Nasser Al Suwaidi said that the development of short-term liquidity management tools represent a "challenge". The UAE central bank is expected to finalize an Islamic CD product for Islamic banks in the next week.

Following a non-deal roadshow, Dubai may issue a 7-10 year sukuk in the next few months with "more generous pricing than a conventional bond" according to fund managers quoted by Arabian Business. If the issue were successfully brought to market, it would reflect a vote of confidence in Dubai despite the continued uncertainty about the final approval of the Dubai World restructuring plan. In addition to being a follow-on sukuk to Dubai's sukuk that was issued shortly before the Dubai World crisis began, it would be notable because there are few issues (much less sovereign sukuk) from the GCC longer than five years. One would hope this would lead to other longer-dated sukuk from the GCC and elsewhere if this sukuk issue succeeds.

Other News

• WealthBriefing has a good article on the lack of diversification options open to ultra-high net worth investors. If these products are not available for ultra-high net worth investors, it is no wonder that there is a lack of options for less wealthy Muslim investors.
  
• An article in Malaysian newspaper The Star touts the recent Malaysian sovereign sukuk. Maybank Islamic recently complained about the lack of scholars "who are well-versed in banking practices".
  
• Moody's estimates that Islamic finance will pass the $1 trillion mark this year. However, accurate statistics about the size of the Islamic finance industry are generally not available, so it is likely an educated guess.
  
• BNP Paribas is expanding its Islamic unit's staffing by 50%, with most of the growth occurring in Asia. The fund management arm of BNP Paribas said it favors sukuk from sovereign issuers in the GCC based on their debt ratings and the oil-generated wealth.
  
• CIMB Niaga, the Shari'ah-compliant subsidiary in Indonesia is planning to expand its lending.
  
• The National Bank of Kuwait's latest ijara fund was fully subscribed in a day.
  
• Ireland wants to capture EUR40 billion in Islamic finance business.
  
• Singapore wants to expand its existing strength as a financial center to expand its role in Islamic finance, although DBS shrank its Islamic unit in Singapore, which was reported to be based on a slow growth in the industry in the city-state. The deputy chairman of the Monetary Authority of Singapore, Lim Hng Kiang, spoke at the World Islamic Banking Conference, Asia Summit.
  
• Edcomm Banker's Academy, a training organization in banking has partnered with the Ethica Institute of Islamic Finance, which offers the Certified Islamic Finance Executive certification.
  

Takaful shortfalls, Islamic money markets, Shari'ah scholars

Takaful
Reuters has a fascinating article about takaful and specifically what happens if the policy holders' pool is in deficit. The article highlights a discrepancy between the regulatory view and the Shari'ah view. The regulatory view says that the shareholders of the takaful provider should be responsible for shortfalls (through a letter of guarantee for any shortfall) and the policyholders should benefit from the gain on any investments financed by the shareholders' funds. However, the Shari'ah view, as articulated in the article, says that policy holders should contribute to finance any shortfall and if there is a letter of guarantee but no cash drawn, the shareholders should receive the benefit. This is an issue that I had not spent much time thinking about, although I have acknowledged that the lack of sukuk and other fixed income products have made a shortfall more likely because the funds contributed by policy holders are invested in riskier assets than the premiums paid into conventional insurers (which are typically invested in bonds). There are no specific examples mentioned, which increases the risk to takaful companies and policy holders without significant experience where shortfalls are actually experienced and managed. However, based on the general trend for Islamic financial products to mirror conventional products, I think it is extremely unlikely that policy holders would be forced to make additional contributions to cover a shortfall.

Islamic finance needs money market to grow
Bloomberg has an article with several interesting comments from Mohamad Nedal Alchaar, secretary-general of AAOIFI. In addition to his comments about the need for more Shari'ah-compliant money market products to facilitate better liquidity management, he warned about "overexposure" to a single industry by Islamic financial institutions. His call is welcome given the fallout from the global financial crisis and property boom and bust in parts of the GCC, and it adds to the recognition that Islamic finance was hurt by the global financial crisis but this damage was accentuated by a concentration of investments in a few industries. He also warned that if there is not more done to create a more transparent forum for Shari'ah scholars to reach consensus from an industry body on products where there are no existing fatawa, the industry would remain dependent on a "fatwa-by-fatwa basis". While it is not surprising to hear the head of a standard setting body call for Shari'ah standards to involve an industry body, his point could strike a healthy balance between individual institutions being able to develop new products if their Shari'ah boards approve and the need for greater consensus among scholars through a central forum without requiring what could become rigid standardized fatawa.

Shari'ah scholars
Another article on the development of a younger group of Shari'ah scholars includes a profile of Taha Abdul-Basser, a scholar and the Muslim chaplain at Harvard University. Congratulations to him for being recognized and profiled as one of the prominent younger Shari'ah scholars who will be responsible for continuing the growth in Islamic finance that the senior scholars helped create during the past 35 years.

Other News

• Qatar issued its first local-currency bond of the year yielding 6.5% and sukuk of the year with a $2.75 billion issue split evenly between a conventional bond subscribed by five conventional banks and sukuk, which was purchased by four Islamic banks.
  
• A firm with links in the Middle East is planning to launch an Islamic REIT in Singapore. There is currently one Islamic REIT in Singapore and plans for another later this year.
  
• Four mostly state-owned companies in Abu Dhabi are cooperating to launch a takaful company in the Emirate.
  
• Tabreed, the National Cooling Company in Dubai which missed a payment on its sukuk, may sell conventional or Islamic debt as a part of its recapitalization program.
  
• A Malaysian firm is planning an Islamic gold ETF in the country. There is currently only one Islamic gold ETF, the Dubai Gold Securities. In addition, companies like Bullion Management Group in Canada offer a gold bullion fund that is Shari'ah-compliant.
  
• The CIS has potential for Islamic finance, but there is little legislation in place that enables Islamic finance, according to a summary of a conference in Moscow written by Mushtak Parker in Arab News.
  
• Indonesian sukuk issuance is expected to rise 10-20% compared to last year according to the CEO of HSBC Amanah, Mukhtar Hussain. He said that the Asian economies have had a limited impact from the European debt crisis. Sukuk issuance was $23.3 billion in 2009, which was lower than the peak of $34.3 billion issued in 2007 according to Standard & Poor's.
  
• The Central Bank of Bahrain short-term sukuk al-salam issue was oversubscribed by over 400 percent. The sukuk matures in 91 days and has an expected return of 0.85%.
  
• Khaleej Times has an article on Islamic finance business education.
  

Dubai World; Islamic 'lender of last resort'

News about possible options for Dubai World continue to surface in media reports and the latest is that Dubai World may seek to simply rollover its debts and lower the interest payments and repay over an eight to ten year period. The outcome for sukuk holders was not discussed specifically in the reports and I am still not sure whether the Dubai World restructuring will include specific accommodations to account for Shari'ah-compliance concerns. In my opinion, and I am not a scholar so I can't speak definitively about this, that any extension of maturity with continued lease or profit payments could be difficult because it would effectively exchange a delay in repayment for a higher level or repayment, which would probably raise some issues. However, I recall that the Nakheel sukuk incorporated defaults by extending the lease term and continuing the lease payments until repayment (analogous to what is being proposed), while retaining the lease as the source of the payments. This would probably be viewed more favorably because it would not include a delay in repayment in exchange for increasing the principal (by making periodic payments for a longer period). However, not all of the Dubai World Islamic debt is structured as ijara. One source in the FT article said that creditors could receive a share of future profits, which could be a way to extend the maturity by turning a murabaha or other facility into a mudaraba or musharaka. However, the lack of clarity on this issue in the media report suggests that there is either a minority of debt that is Shari'ah-compliant or the issue of Shari'ah-compliance is not at the forefront and is being viewed as a later issue when the general terms are agreed for something to be engineered to work around any issues. The National newspaper also offers its slightly different analysis. The Nakheel sukuk are discussed in another article as JP Morgan indicated in a note that sukuk holders could receive repayment at par.

The Union of Arab Banks says it is finalizing a way to allow Islamic banks to approach the central banks of the region for support. This is an important issue because without 'lender-of-last-resort' protection, Islamic banks are more vulnerable to runs. The lack of this support potentially can turn a liquidity crisis at Islamic banks into a solvency crisis if they are forced to unload assets at fire sale prices to meet depositors' withdrawals. This vulnerability should overshadow the more conservative lending standards in the pronouncements of Islamic banks' supposed immunity to crisis. The interbank market is important for banks to be able to have lower reliance on high levels of liquid assets that can reduce their profitability and thus the competitiveness with conventional banks. Following the launch of larger banks like Istikhlaf, which appears only to be an investment bank at the time being, there will need to be more attention paid to the systemic risk posed by larger Islamic banks. Without liquidity facilities at the central banks, investment banks and retail banks in the Islamic financial industry are extremely vulnerably. Beyond the fleeing of depositors in a 'classic' bank run, the demise of Lehman Brothers and Bear Stearns show how a run can start even without depositors if the wholesale funding partners of a bank withhold credit all at once. Both 'classic' and 'Lehman' runs should be considered in judging the urgency of establishing a 'lender of last resort' facility. When there is a new bank with $3 billion in capital expected, this could translate into $60 billion in assets (assuming a leverage ratio of 20:1). That would be a huge institution that would pose systemic risk to the Islamic financial system. It is an issue that deserves a lot of attention.

Other News

• The Dubai Financial Services Authority issued five Islamic finance handbooks for firms operating in the DIFC.
  
• Having announced last year investments in Chicago and a joint-venture with a publicly traded REIT, Kuwait Finance House is planning further expansion in the US, China and Canada. Other Islamic banks have urged China to consider Islamic banking as a way to attract capital from the Middle East.
  
• Indonesia raised 999 billion rupiah ($108.9 million) in its latest sukuk auction with a maturity range of 5 to 15 years sukuk. It had no winning bids for an 11-year sukuk auction. There have been several recent failed auctions for sukuk with investors demanding too high a yield to be accepted by the Ministry of Finance.
  
• Forbes has an article (written by Oxford Analytica) on the moves towards standardization in Islamic finance.
  
• The Islamic Development Bank will soon launch a roadshow to raise money for Istikhlaf, the 'Islamic Goldman Sachs' expected to begin operations later this year.
  
• Dar Al-Arkan redeemed a $600 million sukuk.
  
• The Jordanian government borrowed $100 million from Jordan Islamic Bank to finance a stockpile of wheat and barley.
  
• Centennial College in Toronto will offer an Islamic finance course starting in May.
  
• Has Islamic finance helped cushion Bahrain from the blow of the global recession? The finance minister thinks so.
  
• The Investment Dar continues to struggle on its restructuring and may seek protection under the country's financial stability law.
  
• Amana Takaful, a Sri Lankan takaful provider received an insurance license in the Maldives. The takaful industry continues to struggle over the lack of sufficient supply of appropriate investments, like sukuk, and a shortage of talent.
  

Sukuk: debt vs. equity, Islamic finance assets grew 2008 to 2009

Reuters has a good article on the debate around sukuk and whether they should be more akin to equity or debt. The article includes an update on the progress of the East Cameron bankruptcy. Sukuk holders may propose a reorganization that would give them an equity interest in the underlying company and their counsel expects that East Cameron will emerge from Chapter 11 bankruptcy early next year. The debate over sukuk is one that has been particularly in the forefront over the past two years following the AAOIFI ruling that prohibited mudaraba and musharaka sukuk from including repurchase agreements to redeem them, as well as by several high profile sukuk defaults.

The debate will continue, but the likely end result will probably be a compromise between the sukuk being debt or equity. They will likely continue to be arranged with fixed or variable payments based on an underlying interest rate, making them more like debt. However, they will also probably include more equity-like features that have been included in some recent sukuk. They will also probably move away from the asset-based structure that transform them into unsecured obligations of the issuer. This means that the asset used in the structuring is transferred to the SPV issuing sukuk with a purchase obligation clause at the maturity or in cases of default that gives investors no claim to the asset, only a claim on the issuer.

In contrast to asset-based sukuk, asset-backed sukuk effect a transfer of the asset to the SPV that gives the sukuk holders legal claim to the asset if there is a bankruptcy of the issuer or default on the sukuk. This was the structure of the East Cameron sukuk and one of the issues tackled by the bankruptcy court was whether the sale of the overriding royalty interest to the SPV was a 'true sale' or whether it was only done to create a financing transaction. The court documents suggest that it is the former, which if finalized would create a significant precedent for future sukuk issues in the U.S. A Reuters Q&A provides a similar overview of sukuk and the East Cameron sukuk in particular. A Factbox shows a few examples of asset-based and asset-backed sukuk. Reuters also provides a brief timeline of developments in the sukuk market.

Reuters also presents the views of two experts, an Islamic finance lawyer Megat Hizaini Hassan and the CEO of a Malaysian ratings firm.

A report by The Banker magazine finds that there are assets of $822 billion in Islamic banks and Islamic windows at conventional banks, up 28.6% from the $639 billion estimated as of 2008. The industry, however, continues to miss growth opportunities because Shari'ah-compliant products are more expensive. At a conference in France, the CEO of Renault Nissan Carlos Ghosn said that company would raise money from Islamic investments if it were more cost competitive.

Other News

• The IFC sukuk could prove to be a significant issue despite its small size because it was listed exclusively in the Gulf and the arranging syndicate included mostly Gulf-based firms.
  
• Thailand continues to consider a sovereign sukuk, although it remains at least two years out because of a lack of regulatory changes needed to facilitate the issue.
  
• The Wall Street Journal wrote an article about the need for more trained professionals in Islamic finance and the growth in the number of business schools which offer programs in Islamic finance.
  
• The Irish newspaper The Independent has two articles about Islamic finance including one about how Ireland is considering changes to laws to attract Islamic finance.
  

Islamic Development Bank sukuk, Nakheel update, BNM releases SPR1 on murabaha, Takaful in the U.S.

The descriptions of the Moody's Aaa rating given to the $1.5 billion sukuk provide some details about the way they are structured, a hybrid structure combining the investments made by the bank to governments and companies. The hybrid sukuk combines "ijara assets, murabaha contracts, istisna'a contracts and Islamic Development Bank investments in equity and sukuk certificates". The sukuk represent ownership of the pool of assets which are serviced by the Islamic Development Bank. Profits are paid during the term of the sukuk and the sukuk assets are repurchased upon maturity. One interesting part of the sukuk is that their profit payments appear to be fixed during the term of the sukuk and the SPV issuing the sukuk is given a noninterest-bearing line of credit with the Islamic Development Bank to make up any shortfall in periodic payments. Given the structure of the sukuk in which most of the assets are likely to be ijara, murabaha, istisna'a and sukuk, the profit payments should be relatively predictable. The line of credit makes the sukuk equivalent to senior unsecured debt of the IsDB.

Two large holders of Nakheel's sukuk which matures in December 2009 belive that there will be no restructuring and that the sukuk will be repaid in full upon maturity. Meanwhile Nakheel is apparently selling liquid assets at a steep discount to raise cash to repay the sukuk. The National reports that Nakheel has sold its stake in Australia's Mirvac for 80% less than it paid in 2007.

Bank Negara Malaysia, the Malaysian central bank, released its guidance on the Shari'ah-compliance requirements for murabaha (Shariah Parameter Reference 1) to encourage standardization and is working on similar SPRs for ijara, mudaraba, musharaka, istisna'a and wadi'ah.

Takaful is now available in the U.S. from a subsidiary of now-government-owned AIG that is available through exclusive broker Zayan Takaful. So far the takaful is available in 13 states although only a few hundred people have signed up. The article also has an interesting discussion about differences in opinion about the need for takaful and the acceptability of it in its current form.

Other News

• Al-Arabiya has an article profiling Shari'ah scholar Sheikh Nizam Yaquby.
  
• Sime Darby, a Malaysian conglomerate, is reported to be planning to raise RM4 billion ($1.14 billion) by issuing a sukuk.
  
• Islamic banks grew assets during 2008 compared with 2007.
  
• CNN has a story about the growing demand for Islamic finance education in the wake of the credit crisis which gives a pretty decent summary of how the industry was affected by the credit crisis.
  
• A list of the top Shari'ah scholars and some of the institutions on whose boards they sit.
  
• Islamic indices have underperformed during the past month.
  

The benefits and limits of Islamic finance in the wake of the credit crisis

An article in The Star describes many of the challenges facing the Islamic finance industry including Shari'ah standardization, the shortage of qualified professionals in Islamic finance, development of risk management systems that incorporate the unique qualities of Islamic finance and liquidity management products. One paragraph, however, illustrates a realistic assessment of Islamic finance vis-a-vis subprime lending:

"Notably, Islamic financial institutions are able to make ‘loans’, such as for financing home purchase and could, in theory, have been exposed to subprime mortgage problems. However, their inherently conservative risk management limits not only their ability to lend as a percentage of their own assets, but also the granting of excessive interest rates which enabled unqualified borrowers to take out such loans."

The essence of the argument made, which I believe is accurate, is that creating home financing products for subprime borrowers could easily be done through financial structuring but one would hope that the Shari'ah screening process would exclude those products that are exploitative or deceptive and also ensure that the level of risk taken on by the Islamic financial institution is not excessive. But I think it is important to recognize that products that replicate the seeds of the current crisis could be synthesized (as short sales already have), but if the industry's review process for Shari'ah-compliance works well, the products would nevertheless not be approved.

Andy Jobst, Heiko Hesse and Juan Solé describe the impact the collapse of the securitization market had on Islamic finance and sukuk in particular as well as the differences in Islamic finance instilled through the Shari'ah review process to mitigate conflicts of interest that were made apparent by the recent crisis.

The fall in sukuk in depth, new Islamic bank planned

The IFIS report on sukuk issuance in 2008 is out and it provides a deeper look in the 66% decline in sukuk issuance (with the fourth quarter seeing the lowest quarterly issuance since 2002). One particularly interesting part relates to the idea that Islamic finance was immune from the global credit crisis, which IFIS describes as the Islamic version of the now discredited decoupling theory:

"As the GCC bond market flourished even after the initial impact of the subprime mortgage crisis in 2007, there were those who thought that Islamic finance can withstand this downturn intact due to the nature and features of Islamic banking and finance, and therefore of the sukuk market. This led to some unreasonable expectations for the industry. Some industry observers thought that Islamic finance had successfully separated from global conventional credit markets, which was an Islamic variation on the now debunked decoupling theory. Others claimed that Islamic markets were now mature, independent markets, not related to the price of oil. A third view that was sometimes expressed was that lower leverage and emphasis on holding and selling real, tangible assets will save the industry from the full impact of the subprime crisis and subsequent credit crunch. Essentially, all of the above emphasises the fundamentally different natures of Islamic finance and conventional finance. But the evidence counters this. Sukuk have not done well in the past year. Total issuance in 2008 dropped by 66% compared to 2007, showing no immunity from the global downturn."

As the sukuk market succumbed to the credit crisis, some of the debt finance provided by sukuk was replaced by syndicated lending, according to IFIS.

Despite evidence to the contrary, there are still claims that the Islamic finance system is 'unscathed' by the credit crisis and a belief that if the financial system was structured along the lines of the Islamic financial system, there would not have been a credit crisis.

An un-named Islamic bank with $11 billion will be launched by June despite the challenging market conditions. I would foresee great difficulty for this launch, especially since $10 billion of the initial capital is expected to come from an IPO. The bank's role is compared with that of the European Bank for Reconstruction and Development, which is a regional development bank for Central and Eastern Europe established after the fall of Communism.

Other News

• Malaysia's sukuk market is expected to be $4 billion in 2009 compared with $5.86 billion in 2008, which was already a steep (78%) drop from 2007.
  
• Turkey's government announced a sukuk expected to be issued by the end of January to raise $1.15 billion, called "Rent Certificates" linked to the income at four state-owned enterprises.
  
• There are no Muslim faith based debt counselors in the U.S. because "there is no need for a debt-counseling service company, because a practicing Muslim doesn't subscribe to debt service products, such as credit cards"
  
• Bahrain Islamic Bank report falling profits in the wake of the global credit and economic crisis
  
• An existing bank in London, BLME, is starting a new private bank in the U.K.
  
• Another university in Europe, this one in France, is starting an Islamic finance degree as Paris Europlace, the Paris Financial Center, tries to attract Islamic finance to France
  
• Indonesia may extend the term of its forthcoming retail sukuk from three years to five

Correction: I mentioned the $4 billion in debt that Emaar listed on the London Stock Exchange. Of this amount, the European MTN were conventional debt and $2 billion were sukuk.

More sukuk details, Malaysian High Court challenges BBA

The reports that sukuk issuance fell significantly in the first half of 2008 continue to slice and dice the details of changes within the market for sukuk. A recent report from the Islamic Finance Information Service (IFIS) shows that in addition to a fall in issuance by 54% in the first half of 2008 compared with the same period in 2007, the issuance of sukuk are coming more from the GCC, denominated in local currencies, particularly the UAE dirham, and are significantly smaller than older sukuk. Highlights from the report include:

• 61 (valued at $11.55 billion) in H12008 versus 111 ($25.0 billion) in the same period in 2007 and 77 ($13.67 billion) in H12006;
•More sukuk were issued in the GCC than in southeast Asia and the Malaysian Ringgit fell behind the UAE dirham, albeit only slightly, as the currency of choice for issuers;
• In the first half of 2008, only 2 sukuk were issued for more than $1 billion compared with 14 during the full year 2007. Most sukuk in the GCC were greater than $100 million, while Malaysian issues tend to be smaller than $100 million.

The Malaysian High Court ruled that a common product used for home finance, al-bai' bithamen ajil (BBA), is not Shari'ah-compliant and therefore contrary to the country's Islamic banking law passed in 1983. The BBA transaction involves the sale to the bank at par with a resale back to the customer with a deferred repayment. The criticism of the BBA by the High Court was that the sale involved in the transaction was not a 'true sale' but was merely conducted to create a financing activity. There was some disagreement between industry players and academics about whether this ruling would force the restructuring of BBA home finance products. The use of Shari'ah standards that are more liberal than in the GCC has hampered the ability of Malaysia to internationalize its Islamic finance industry as much as other countries. This High Court ruling may be an attempt to force the domestic Islamic finance industry to adopt more conservative standards to better place Malaysia for growth within southeast Asia as countries seem to be adopting more conservative GCC Shari'ah standards.

Diversification of assets and liabilities continues to pose a significant problem for Islamic banks. There are not enough Shari'ah-compliant assets available to diversify to mitigate risk from over-concentration in one asset class and geography.

There is a special feature in MEED on Islamic finance. In the introductory article, MEED writes: "In the first seven months of 2008, $73bn worth of sukuk were issued worldwide" citing a Standard & Poors report. The report showed $14 billion in sukuk through the first eight months of 2008 (through August 31, 2008). The remainder of the article was behind the subscriber wall, so I was not able to see whether there were additional mistakes in the rest of the special report.

The Academy for International Modern Studies, a research & educational body associated with the UK government, will offer its programs in Nigeria.

Islamic finance & microfinance, law firms see need for Islamic finance expertise

John Foster comments regarding Ramadan touch on the idea that GCC-based Islamic financial institutions could make a huge difference in reducing poverty if they devoted a fraction of their resources to helping provide financial services to the poor in nearby countries in Asia and Africa.

The head of global strategy for Reed Smith L.L.P., a law firm based in Pittsburg, Pennsylvania, responds to a question about why they feel they need to have expertise in Islamic finance.

Q: Do you have an Islamic finance practice?
A: We do have some Islamic finance work out of Dubai and Abu Dhabi. It is increasingly important because that is where the money is. Let's face it: Money is basically pouring into the Middle East and, to the extent that it is going to be invested in debt instruments, it will have to be in instruments that are sharia [the Islamic legal code] compliant, and you have to have expertise to do that.

DIFC Authority CEO Nasser Al Shaali says that Islamic finance is providing one of the driving forces attracting "new, more sophisticated investors".

La Trobe University in Sydney, Australia launched the country's first master's degree in Islamic commerce.

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

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

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

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

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

Education on Islamic finance in the U.K.

The Independent (U.K.) discusses the growth and demand for education in Islamic finance in the U.K., currently offered at the Cass Business School, Lancaster Business School, Bangor Business School, Durham University and the Chartered Institute of Management Accountants (CIMA).

Islamic finance growing rapidly, other news

Islamic finance continues to grow rapidly.

Thailand hosts conference to attract firms in the halal market to the country. This, and other conferences, are listed on the IHI conference listing page. The International Center for Education in Islamic Finance (INCEIF) signed a memorandum of understanding with a Thai University, Chulalongkorn University, to atract more Thai students.

Malaysia is deciding whether to allow foreign banks to open standalone Islamic banks in Kuala Lumpur. The new Malaysian proposed budget includes many tax breaks to attract Islamic finance companies and experts

Takaful growing rapidly in Brunei.

Islamic banking, sukuk tax changes hailed, IF education scholarship fund

A good article by the Assistant Editor of CFR.org, the website of the Council of Foreign Relations about the growth of Islamic banking.

The British organization the Tax Incentivised Saving Association (TISA) is supportive of moves by the British government to change tax rules to put sukuk on equal footing with conventional bonds.

EONCAP Islamic Bank makes the first contribution to the INCEIF scholarship fund, the "Fisabilillah Trust Fund". The contribution is for RM400,000 (US$114,669).

300th post: INCEIF, halalness of forex trading

International Centre for Education in Islamic Finance (INCEIF) is seeking donors to fund scholarships for students needing assistance while completing their Certified Islamic Financial Professional (CIFP) program.

A workshop is being held in Brunei to discuss the 'halalness' of foreign exchange trading.

An article in Epoch Times (an online newspaper) about Islamic finance and a recent IMF paper discussing how Islamic finance fits into the regulatory systems which were designed for conventional financial institutions.

Growth of Islamic finance in Scotland & Sri Lanka, Islamic finance education standards

One of the challenges in Islamic finance is education standards across the globe (Reuters), with different training programs in Malaysia, Bahrain and the U.K.

Islamic finance is growing in Scotland (The Scotsman, U.K.).

ABC Investments, a new Islamic investment group, will expand to other areas within Sri Lanka (Lanka Business Online, Sri Lanka) besides Colombo, the only area in which it currently operates. Mohammed Razeek, the firm's managing director, explaining a new plan for funding construction of middle-class housing describes "We will not go into providing luxury apartments as a lot of companies already have done that.”

Standard Chartered Bank Malaysia Bhd, the Malaysian subsidiary of the large U.K.-based bank, wants to expand its banking assets in Malaysia (Business Times, Malaysia)with a focus on Islamic banking.

"The Securities House [of Kuwait] announced that it has incorporated a wholly-owned public limited company in the UK, which is currently applying for a license from the Financial Services Authority (FSA) to act as a deposit taking banking entity within the UK regulatory environment. The new company intends to establish itself in London as a Shariah compliant wholesale investment bank, focusing on the Islamic capital markets, Islamic treasury business and asset management." Securities House Press Release, July 18, 2007

The Toronto Star (Canada) has an article about the growth of the halal industry in Canada over the past 30 years as the Muslim population has grown from 70,000 in the 1970s to 850,000 today. The potential for Canada to be a global hub in halal products will be difficult given the attention the halal industry receives from the Malaysian government.

Islamic banking, durra and IFC investment in Islamic finance

The International Centre for Education in Islamic Finance (INCEIF) held a conference in Yemen about the challenges facing Islamic banks. Another conference in Bahrain discussed the growing prominence of Islamic banking. In Kenya, the lack of a Shari'ah-compliant interbank money market raises questions about the viability of Islamic banks in the market, particularly the recently opened First Community Bank.

Women in the UAE's Islamic finance industry are pushing for a greater number of female senior executives.

The International Finance Corporation (IFC), the private sector arm of the World Bank, will invest in Islamic mezzanine notes issued by Tamweel. The issue will be the first Shari'ah-compliant multitranche mortgage-backed security in the UAE. IFC hopes its investment will help "develop long-term capital markets in the GCC and expand availability of Islamic finance products" according to Lee Meddin, the IFC Deputy Treasurer and Global Head of Structured Finance.

The Waqf Fund established by the Central Bank of Bahrain in 2006 will have a special fund to support Islamic finance education & training.

Gulf Finance House GDR priced at $2.5 per share.