GCC issuers looking to Malaysian sukuk markets

An article in Malaysian newspaper The Star describes a potentially troubling development for sukuk markets in the GCC.  The article describes the growing likelihood that Gulf-based corporates will look to Malaysia when they choose to issue sukuk.  The sukuk market in Malaysia (primarily denominated in Malaysian Ringgit) is much more developed than the GCC, particularly the secondary markets for sukuk.  If corporates from the GCC become issuers in Malaysian markets, it would hurt the development of secondary markets in the GCC and could also cause difficulties for the GCC firms themselves depending on the direction of the dollar's value (to which most GCC countries have pegged their currencies).

The article describes that corporate issuers are issuing Ringgit-denominated sukuk to tap an investor base that is estimated at US$79 billion, much of which can only invest in Ringgit-denominated assets.  This would undoubtedly be a positive for Malaysian markets and investors.  Investors would have a larger prospect for diversification among sukuk issuers than they have now and the larger number of sukuk could put the secondary market development into a self-reinforcing (positive) cycle of more sukuk leading to more secondary market trading, which would then lead to more issuance.

However, exactly the same logic of a self-reinforcing cycle could start in the GCC with fewer sukuk being issued in the GCC, which would lead the secondary market to become squeezed for new issuance to make up to redeemed or defaulted sukuk. This would see a contraction in the already small trading volumes of sukuk, which would further limit the supply of new sukuk.

Another potential problem this could create for GCC-based issuers of sukuk is that they would have exposure to exchange rate risk.  This could be a positive for those issuers with a significant share of revenues and expenses denominated in Ringgit.  These issuers would then have debt payable in the same currency as their revenues, which would act as a currency hedge.  However, issuers with most of their revenue denominated in USD or UAE dinar or any of the other GCC currencies that are tied to the US dollar would be at risk of having their debt service grow in local currency (USD/AED/SAR) terms if the Malaysian Ringgit appreciates further against the US dollar (and effectively appreciates against GCC currencies).

It may be that the issuers of these sukuk expect the appreciation of the Ringgit against the dollar to reverse, which would lower their debt service in their local currency.  However, with underdeveloped mechanisms of hedging against currency risk in a Shari'ah-compliant framework, creating mismatches between the currency where the cashflow is generated and the currency in which debt service payments are made it adds a risk that could hurt the companies that could issue sukuk within the GCC as its sukuk markets develop.

Guest Post: Is foreign-exchange trading halal?

There has been much debate in Islam concerning whether trading in the spot foreign-exchange market is halal or haram. Islamic law is fairly straight forward concerning what is acceptable in regards to economic activity and what is not, but still many Shari’ah scholars have built formidable cases on both sides of this topic. Unfortunately, there is no crystal clear conclusion on this heated topic. In this article, we will break down each side of the debate and discuss where the concerns are on both sides.

First of all, Islamic law forbids a person to sell that which he does not possess. Many scholars believe that trading in the FX Market is not permissible under Islamic law because it involves buying or selling a currency which one does not actually own. In the spot FX Market a trader generally trades on leverage, meaning he may control a $100,000 position in the market with just $1,000 in his account. Thus, he is essentially making transactions with money that is not his, and according to the strict letter of the Islamic law, many scholars believe it is not right.

However, other scholars argue that the scriptural context of this law is referring to physical goods such as livestock. Thus, if a person were to find a lost camel, and he tried to sell it without notifying the owner, this would be haram, or against Islamic law. But these scholars argue that dealing with currencies is not the same. They argue that a trader is not really selling something they do not have as in the case of the lost camel.

Second of all, Islamic law forbids entering into an agreement in which an additional amount is added to a loan, which is called “paying fees for delaying the deal.” Unfortunately, this is exactly what happens when an FX trader holds a trade overnight. He is charged a small fee by the broker, which essentially involves paying fees for delaying the deal. Scholars believe this aspect of spot FX trading makes FX trading haram, but many retail brokers have adapted to Islamic law and instead of charging traders an overnight swap fee, they are simply adding an additional “administration fee” on to each contract a traders trades. Scholars who believe FX trading is halal believe that this move by forex brokers breaks down the haram argument surrounding this specific issue.

Third of all, Islamic law forbids usury and taking advantage of another person in economic dealings. Many scholars are concerned that spot FX trading in a forex account can be labeled as such due to the fact it is a zero-sum game. This means that when a trader closes out for a winning trade, the only way he has profit is by another trader having a loss. In Islamic law this is seen as immoral and not to be done; therefore, many scholars see this point as haram. However, the other side of the argument is that not every trader on the other side of your trade is losing money. For example, if you a trader is in a long position and needs to close it out by executing a short position, the trader that is short may be in a lot of profit as well, but he may just have a longer-term or shorter-term position he is managing. Thus, it is not necessarily true that an FX trader only makes money when another trader is losing money. Thus, many scholars argue that this point is further evidence that FX trading is in fact halal.

As you can see, the debate whether FX trading is halal or haram is very debatable. Very respected scholars in Islam are pitted on both sides of this argument.

This guest post was contributed by Bryan Sayers. He is the editor of Forex Fraud, a site is designed to help protect investors from forex scam, commodity fraud, and other investment scams.

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

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.
  

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

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

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

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

Other News

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

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.