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.
  

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.
  

A scholar raises issues of copy-cat products, IFC sukuk, South Korea considers sovereign sukuk

Shari'ah scholar Dr. Hatem El-Karanshawy, a former director of the Central Bank of Egypt, cautions the Islamic finance industry on 'Islamizing' products that do not inherently fit with Islamic principles. He says that venture capital can fit in well with few modifications. The growth in Islamic finance has been accompanied by 'copy-cat' versions of conventional financial products using contracts that allow Shari'ah scholars to approve them. In many cases, these products do provide value, but as I mentioned in a blog post two months ago, there is a need to keep in mind whether new innovation is beneficial in Islamic finance just as in the conventional financial industry.

The International Finance Corporation's $100 million sukuk is receiving favorable coverage from Arab News, which points out that many Arab countries have not yet stepped into the Islamic capital markets to raise funds. In addition to the most recent sukuk (and a Ringgit-denominated one it issued in 2004), the IFC has been involved in several other Islamic finance transactions over the past few years.

South Korea appears to be the latest non-Muslim majority country to work to attract Gulf money by passing laws that put Islamic finance including sukuk on equal regulatory and tax footing to conventional bonds. The country recently announced a list of state-owned companies that the government is looking to privatize and which it seeks Gulf investment. In addition, the government is considering an $80 billion initiative for environmentally-sustainable areas of growth. The government is also on a roadshow to gauge interest in a $500 million - $1 billion sovereign sukuk.

Other News

• HSBC is considering subscribing to the second $10 billion tranche of bonds issued by Dubai. The first tranche was purchased by the UAE central bank.
  
• Islamic banks' assets grew by 66% between the end of 2007 and the end of 2008 according to the Union of Arab Banks.
  
• The NY Times published an article on the growth of Islamic finance in universities' curricula.
  
• According to Standard & Poor's, the performance of Shari'ah-compliant equities lagged in the third quarter, a period when a lot of the leading stocks were financials.
  
• Bahrain-based Al Baraka plans on spending $30-$50 million on a bank acquisition in Indonesia. The bank also says that the IPO of its Syrian unit is oversubscribed.
  

Is innovation in Islamic finance always good?

Emirates Business spoke with a number of Islamic finance analysts and one point of consensus was that the Islamic finance industry is not yet viewed as a credible alternative, in part because it is not well understood globally but also in part because there are questions about products which use different means to essentially replicate conventional products. One of the suggestions was that particularly outside of the GCC, Islamic finance should drop the use of Arabic terms to emphasize that the industry does not exclusively target Muslims. This is a point I have heard from other people with in the industry, but replacing the Arabic product names, particularly while retaining the 'Islamic' label could diminish the ability to focus on the differences in how products are structured compared to conventional products, in large part because the outcome is in many cases nearly identical.

This article also leads to consideration of another important question about whether the focus on 'innovation' as it relates to mimicking additional conventional products (for example, Islamic hedge funds and multi-tranched sukuk) makes sense for the industry as a whole. There is clearly room for innovation in Shari'ah-compliant products, but just as the debate rages in the conventional financial world about whether financial innovation is beneficial for society, I think it is important to consider the question about which innovations are beneficial for the investors in the products or whether they are simply a new product that can contribute to the profits of the firms structuring them.

In contrast to the innovations that merely mimic more complex conventional financial products, the focus of innovation would be more beneficial were it to focus on developing alternatives for controversial but incredibly necessary products like commodity murabaha/tawarruq. These products have come under fire recently for their similarity with interest-based products where there is only nominal trade in an underlying asset in order to structure short-term liquidity management tools.

Another area where the industry's efforts would provide a real benefit to the industry would be in creating more standardized types of sukuk which could be priced competitively with conventional debt. Were there ready-made sukuk structures that were accepted by the majority of scholars--an easy one to start with would be ijara--then it could reduce structuring costs and encourage issuers to bring sukuk into the market. The use of similar structures by a broad number of issuers would also have the effect of increasing the comparability between different sukuk issues and holders of one sukuk could use standard credit analysis to compare it to other sukuk in the secondary market without worrying that structuring differences would lead one sukuk to behave differently, for example if there were a default.

Innovation can benefit both the developers of the innovation as well as the broader Islamic financial industry, but this need not always be the case. For example, the Total Return Swap engineered by Deutsche Bank was certainly an innovation--it used a wa'd swap to create a Shari'ah-compliant wrapper for non-Shari'ah-com-pliant hedge funds--but it also led to Sheikh Yusuf DeLorenzo to dub the fatwa permitting it as the "Doomsday Fatwa for Islamic Finance". He dubbed it thus because if it is possible to use a wa'd swap instead of an alternative structure, it makes it possible for any non-compliant product to be fairly inexpensively wrapped using the wa'd swap and could compromise the legitimacy of the entire industry if adopted throughout. Innovation in finance is different from innovation elsewhere because it is possible for the innovation to do little more than generate profits without contributing any broader benefit. In the wake of the global credit crisis, in part caused by this type of innovation, the importance of considering whether a given innovation is beneficial or detrimental.

Another excerpt from the Yasaar Media's Islamic Investment Banking 2009 report is published in AMEinfo, this one focuses on venture capital.

Islamic private equity could be the beneficiary of asset fire sales and mergers & acquisition activity following the economic downturn according to the managing director of Rasameel Structured Finance, Issam Al Tawari.

Other News

• The rankings of largest banks in the GCC is out with four of the banks located in the UAE.
  
• Malaysian asset manager Corston-Smith is planning a $282.5 million Shari'ah-compliant fund.
  
• QInvest has proposed launching a $200 million Shari'ah-compliant fund focusing on shipping assets.
  
• The Azerbaijani Islamic financial industry remains nearly non-existent because there are no laws authorizing Islamic banks, but this could change in the future as there is one bank that now offers Shari'ah-compliant products, although not murabaha due to regulatory restrictions.
  
• Mauritius continues to try and attract Islamic finance as an attractive location to structure Islamic financial products.
  

Islamic finance in the West: Can it survive and thrive?

Emirates 24/7 has an open article about whether Islamic finance will succeed in the West. There are some factors that indicate high potential for Islamic finance to succeed, while other factors that could limit the industry's growth in the West. On the positive side, Islamic finance has many similarities with socially responsible investing. The socially responsible industry in the West has grown rapidly and there are now over $1 trillion in assets under management that go through at least one ethical screen. Because Islamic finance shares many of the socially responsible screens, there is great potential to use the same techniques used by Islamic finance to broaden socially responsible investing to other areas of finance. On the negative side, the Muslim population in the West is relatively small compared with other areas like Malaysia and the GCC, so there is a limited base of consumers who would be willing to use Islamic financial products, even if they are more expensive initially. There are also some significant legal, regulatory and tax changes required to put Islamic finance on a level playing field with conventional finance that may not necessarily be made. On balance, positive regulatory support reported by some within Islamic finance and the strong interest in ethically-based finance support the potential for Islamic finance, in my opinion.

Dr. Malik Muhammad Al-Awan, director at Furqan Research, belives Islamic banking in Malaysia should focus on developing innovative new products to support and accelerate its growth. The growth in Islamic finance should continue because of high commodity prices creates greater liquidity in and demand for Islamic finance products.

Takaful premiums have grown rapidly in the last year, although its size and development continues to lag the Islamic finance industry as a whole. Last year, total takaful premiums were $2 billion and are expected it increase to $7 billion in 2015, an annual growth rate of 17% per year. The total assets of takaful providers in Malaysia are $2.5 billion, 6.8% of the total assets of the insurance and takaful industry in the country. Globally, there are now over 120 takaful providers. Many of these providers are investing assets in sukuk, potentially contributing to the excess supply (and buy-and-hold mentality) which has contributed to slowness in the secondary market for sukuk .

Euromoney has an article on opinions of fund managers about offering Shari'ah-compliant versions of their funds to attract institutional and high-net worth money from the GCC region. FinanceAsia.com has an article about how Islamic finance is finding ways to replicate more complex financial structures in sukuk.

Sukuk, India, France, Kenya, growth in Shari'ah-compliant equity investing

North Africa is beginning to see more growth in Islamic finance, although the higher cost of Islamic finance products is proving to be a greater hurdle than in the GCC countries, where consumers were less sensitive to cost initially. However, like the GCC where consumers are becoming more sensitive to the cost of Islamic financial products, some banks in Tunisia and Morocco have begun to offer Shari'ah-compliant products which are cost competitive with similar conventional financial products.

During the recent worldwide boom in equities, Islamic finance was seen to be underperforming conventional alternatives, but the credit crunch and slump in equity prices has led to changing opinions about the relative performance and riskiness of Shari'ah-compliant versus conventional investments says Jahangir Aka, senior executive of SEI in the Middle East. The avoidance of the financial sector is just one reason these funds have been more stable than conventional alternatives over the previous year. The greater due diligence and 'buy and hold' investment approach, along with the avoidance of highly leveraged companies, has led to more robust returns in periods of instability in the financial markets. Gartmore, a UK-based investment company, has also pointed out that investors see greater safety in Shari'ah-compliant methods of financing due to the recent volatility and Islamic finance's reliance on 'real assets' to underpin financing.

The lack of market makers in sukuk has slowed the development of a secondary market and made it difficult to determine current value of outstanding sukuk issues. The lack of qualified professionals, as well as scholars, is still currently threatening the sustainability of current growth rates in Islamic finance. This shortage has spurred the development of new academic and professional training schools for Islamic finance professionals. One group of professionals who are entering Islamic finance rapidly is lawyers.

Islamic banking advisor Lahem Al-Nasser argues that many of the new products offered by Islamic banks are nothing more than new marketing methods, like a credit card in Saudi Arabia that earns airline miles. Instead, Islamic banks need to encourage more creativity by not focusing too much on expenditure for new product development or dismissing those who develop unsuccessful products, which he believes "cripples creative thinking". The growth in Islamic finance products and development of new products, however, is not entirely without controversy.

A contributor to CPI Financial discusses the different ways to replicate short selling in Shari'ah-compliant ways.

Despite having great potential for developing a market for Islamic finance, France has been slow to encourage growth in the industry, says a special comment from Moody's Investors Service. In contrast, Kenya has seen its Islamic financial industry growing rapidly as banks begin to offer a growing range of Islamic finance products. India's Islamic finance industry is just beginning to start growing rapidly and some companies like Reliance Money, have begun expanding into the GCC offering Islamic financial products.

Innovation & Standaradization, Islamic Finance in the U.S., Africa, Malaysia & the U.K.

The focus of the International Islamic Capital Market Forum in Malaysia was how to get different "Shari'ah jurisdictions" to cooperate. The growth in Islamic finance, and particularly growth of GCC and Malaysian organizations into each other's region, has led to significant standardization of Shari'ah standards. The rapid growth of Islamic finance does necessitate some standardization to reduce the costs associated with Islamic financial products over and above conventional products. However, too much standardization in current products, most of which replicate conventional products in a Shari'ah-compliant way, could reduce the degree of innovation in Islamic finance. The Bank Negara Malaysia, the Malaysian central bank announced the establishment of the International Shari'ah Research Academy for Islamic Finance (ISRA) as a center of knowledge in Ilsamic finance.

USA Today profiles Devon Bank, a community bank in Chicago that offers Islamic finance. Another organization, SASSO, provides training and Islamic financing in the St. Cloud, Minnesota area.

The Islamic financial industry in Africa is growing rapidly as well as in places more commonly associated with Islamic finance like the CGG and Malaysia. Islamic finance accounts for over 15% of the total assest in the Malaysian banking system. The U.K. is quickly emerging as a center of activity in Islamic finance in the West, although the performance so far of Islamic banks have not been great.