Blog changes

Until now, I have focused on trying to give a summary of the events in Islamic finance that I think are important, but I often resort to bullet points to give the more 'minor' articles coverage.  Going forward, I am going to eliminate this because it is too time consuming with relatively limited benefit to readers.  As you may have noticed, I have added a feed from Opalesque's Islamic Finance Briefing.  This is the best source I have found for current information on new articles and I think it and other feeds to be added will be a better and more up-to-date source for current news on Islamic finance.  The blog will focus on the articles that I feel deserve additional commentary (supplemented with more focused commentary in the weekly newsletter, which you can sign up for on the left side of the blog).  I think this change will benefit both the reader through more attention to the commentary and my increasingly busy schedule and result in more frequent posting.  I welcome comments on what is valuable and what is better left to other sources either through comments or by emailing me at blake@sharingrisk.org.  As always, I will try to promptly return any direct emails about the blog or questions about Islamic finance and I hope the change to the blog will make it easier for me to reply quickly.

Dubai update, Islamic finance & foreclosures

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

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

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

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

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

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

Friday Bullets

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

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

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

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

Other News

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

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

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

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

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

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

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

Other News

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