S&P disconnect on Islamic finance

One of the longstanding themes of coverage of Islamic finance is that it will grow rapidly once it starts to be tapped to fund infrastructure projects.  This may be the case--one could reasonably expect some of the money in the GCC looking for a long-term, relatively stable investment (not to mention something which is needed in many areas)--but when S&P takes this type of thesis one step further to suggest that Islamic finance (sukuk in particular) would be well suited for funding the $8 trillion in infrastructure projects needed in Asia over the next decade, it might be one step too far. 

What is this really saying?  Is there really demand enough among Asian investors for $8 trillion in new sukuk during the next decade.  That's $800 billion, more than 10 times the likely issuance this year.  S&P does not suggest that Islamic finance will play a "key role" in funding the infrastructure projects.  Perhaps the phrase "Islamic finance" might just be a way of saying "oil money from the Middle East". 

Ok, perhaps I'm too cynical about S&P's analysis.  But they finish the press release: "In our view, Islamic finance would be a good match for financing Asia's infrastructure funding gap, especially sukuk bonds. The Sharia principles governing Islamic finance ban speculation and specify that income must come from shared business risk. What's more, Islamic finance is based on the concept of asset-backing." 


S&P, a company that has standards for rating different types of sukuk--asset-based, asset-backed and other--yet it falls into the same old "Islamic finance is based on the concept of asset-backing".  When I see simplistic (and incorrect) descriptions of Islamic finance used by people or organizations who should know better, it makes it more likely in my opinion that the article found an area where there is a funding gap, noticed that there are large flows of capital into the GCC and used Islamic finance as the link between that supply of and demand for that money.

Indonesia plans sovereign sukuk, targets GCC

Indonesia is planning another dollar-denominated sukuk sale and there were a few interesting points highlighted by the Jakarta Globe.  The sukuk will be targeted at Middle Eastern investors, who accounted for 30% of the buyers in the last sale, which was heavily oversubscribed.  Rahmat Waluyanto, director general of the debt management office at the Ministry of Finance, told the Jakarta Globe, "We are targeting Middle East investors to buy our global [Islamic bonds] [...] Investors from other parts of Asia, Europe and the United States are also welcome."  The last sale was subscribed primarily (40%) by Asian investors, with Americans (19%) and Europeans (11%) making up the balance.  With the market turmoil, particularly in Europe, since the first one this sukuk could signal whether investors are continuing to pour money into emerging market sovereign sukuk.

Sukuk in the next year

The sukuk market has been one of the most commonly discussed areas of Islamic finance, and not without reason. It is one of the more dynamic (and cyclical) parts of the Islamic finance industry. It has also been an area that companies from the West and multilateral institutions (GE Capital, the World Bank, the International Finance Corporation, for example) have become engaged with the Islamic finance industry. When the sukuk issuance volume collapsed in 2008 and early 2009, it was viewed as the end of growth beyond 'traditional' markets for Islamic finance. This was, of course, a rush to judgement, but the rush was on in all areas from the conventional financial sector in the West, Islamic finance and in equities. In a crisis, the first thing that is lost is optimism for the future.

In the year following the bottoming of equity markets in the West following the crisis, the sukuk markets became divergent. Initially, the drop in issuance was more pronounced in the Asian markets and the GCC was able to continue on (in part, probably due to a recovering price of oil). However, around November 2009, with the onset of the Dubai debt crisis and the oncoming maturity of the $3.52 billion Nakheel sukuk, the trends changed sharply. The GCC was viewed as too risky and demand dried up for new sukuk. The primary issuance was from sovereigns with a few corporate issuers sprinkled in here and there. In contrast, the Asian sukuk markets rebounded sharply and issuance of sukuk (along with the equity markets in countries like Indonesia and Malaysia) grew rapidly. However, the recent news indicates that the growth in sukuk may be returning in the GCC and also to the West (particularly the UK, with politics interfering in the US--see my post on Thursday). Consider the headlines from just the last couple of days.

• "Sukuk Entice Canada Issuing $2 Billion to Spread Funding: Islamic Finance"
  
• "UK government ‘seriously considering’ first sukuk issue "
  
• "Gatehouse plans to launch Pounds70m sukuk next month, says chairman"
  
• "Saudi Aramco, Total ink $1b Sukuk for Jubail JV"
  
• "Saudi firms to launch 10 sukuk"
  
• "Nakheel to issue sukuk by January 2011 - CEO"
  
• "Abu Dhabi Islamic to Meet Investors Before Bond Sale"
  
• "Sukuk eye record on Asia growth and Gulf issuance"
  
• "GCC bond issuance jumps 140% in Q3" (Conventional)
  
• "Emirate of Ras al-Khaimah eyes benchmark bond issue-paper" (Conventional)
  

Arguably, the two most important sukuk coming are the potential UK sovereign sukuk and the Total-Saudi Aramco sukuk. The former would be the completion of an effort that has stretched back several years to when Gordon Brown was prime minister. The latter would be important because of its potential size. The $1 billion sukuk would be one portion of at least $12 billion in total cost of the planned Jubail refinery.

In the regrowth of GCC credit markets, it is interesting, but not surprising, that the conventional bond market in the region has rebounded quicker following the first part of a Dubai debt restructuring and the expected resolution of trade creditor's claims of Nakheel (which will also include a sukuk for 60% of the claims). According to NCB Capital, conventional GCC bond issuance rose from $4.5 billion in the second quarter to $10.8 billion in the third quarter (14 issues in Q2 versus 26 issues in Q3). During the last quarter, issuance in the GCC was below the level of the first quarter of 2010 even as total issuance was $10.3 billion in the quarter ($9.2 billion of which came from Malaysia).

In addition to the potential issuance from the GCC, which would follow the recent growth in the conventional bonds from GCC issuers, one of the notable pieces of news is that there may be corporate and government-related sukuk coming from Canada, which has not been the source of any sukuk so far. According to Omar Kalair, the CEO of UM Financial, which is based in Toronto, HSBC Bank Canada may offer $500 million and three government-related borrowers from one Canadian province may issue $1.5 billion of sukuk (quoted by Bloomberg). As the past few years have demonstrated, the potential for sukuk is only a guide for future issuance, but regardless, it is another step forward for the internationalization of Islamic finance that new issuers could enter the market.

The fourth quarter will be a good guide to whether the regrowth of sukuk issuance globally (particularly ex-Asia and in the West) will likely continue into 2011 and the breakdown between sovereign/corporate, regional and the different structures will provide a guide to what the next year and more will bring.

Sukuk issuance from Europe, Amlak & Tamweel merger 'unlikely'

The Bank of London & the Middle East (BLME), a UK-based Islamic wholesale bank launched a division to advise on sukuk to attract investors from the GCC and Asia to UK and European companies. They expect to close their first deal within a year. The move comes shortly after the first UK corporate sukuk was launched. I have not had a chance to view the prospectus for that sukuk, but it was a 5-year convertible musharaka sukuk (with 10% coupon) issued to one investor, Millenium Private Equity. The conversion from debt into equity will occur on the meeting of pre-determined performance milestones, according to an article in Khaleej Times. The structure is likely to be complicated to incorporate both the convertible nature of the sukuk with a fixed coupon and remain in compliance with the new AAOIFI rules on musharaka sukuk. However, from the perspective of a private equity investor, the structure of a sukuk rather than an equity contribution makes sense. It gives the investor a higher priority claim on the business' assets than equity and also a coupon, although that will be unlikely to benefit the investor if the sukuk sours. The coupon on the sukuk (if both principal and coupon are convertible) provides the company with the incentive to meet the milestones for conversion earlier because the accrued coupon payments will translate into more dilution for the company's other owners the longer it takes to reach those milestones. One of the features of a musharaka is that both partners are permitted to be engaged in the management of the business (akin to private equity investors taking board seats of companies they finance). At the risk of generalizing without having read the prospectus myself, this structure sounds like a good way for Shari'ah-sensitive private equity investors to both provide themselves with greater security (or equivalent security to conventional private equity) but also use a structure that some scholars describe as "more genuine".

The Amlak and Tamweel merger is now 'unlikely' according to the chairman of Tamweel following Dubai Islamic Bank's acquisition of a majority stake in the Islamic mortgage company in Dubai. The lender still has a significant way to go before it can resume operations as normal and will likely need a capital injection. Tamweel is working on a plan to resume lending in the market and expects to release a plan in 'the next few months'. Another article citing the chairman of Tamweel says that they expect Q3 results to resemble the first two quarters of the year. They took significant provisions in 2009 and expect to "translate our revenues into some profits". In many ways the issue facing Tamweel is similar to what is facing other mortgage lenders in countries that have experienced a real estate boom and bust. The pain may be over (or nearly over) but a resumption of 'business as normal' will not happen overnight. The economic recovery globally has remained slow and the appetite for new debt is likely to be significantly constrained (the 'new normal'). The recovery for mortgage lenders like Tamweel will most likely be slow both because borrowers are more hesitant to take on new debt but also because the standards on which Tamweel will lend are likely to be far more stringent than before the property bubble collapsed.

There is a fantastic article in The Asset magazine about an interview with CIMB Islamic CEO Badlisyah Abdul Ghani that covers a broad variety of topics including the impact (and potential impact) of the credit crisis on Islamic finance and the need for better regulation of Islamic finance. It is a good, brief read. A few exerpts:

"One reason why Islamic banks were not as affected as conventional Western banks, argues Badlisyah, is that they were not sophisticated enough to participate in derivatives and other leveraged transactions. "The situation could have been much worse if the Islamic banks had been as sophisticated in employing leverage as their conventional banks’ counterparts were in the previous years."

"As in conventional finance, he says, Islamic finance relies on the creditworthiness of an issuer or a client to decide where liquidity is channelled and directed. "Whatever structure is in place – whether it is Islamic or conventional – credit is still credit and it needs to be paid."

"Badlisyah argues that everything that exists in Western capital markets that is of genuine value to banks and corporates has already been incorporated in Malaysia under the Islamic derivatives regime. This, he argues, is the reason why Malaysian Islamic banks have been successful in managing the volatility and fluctuations that have buffeted the industry in recent years. The ban on credit default swaps is completely justified, he feels, and will likely be for keeps."

"From Badlisyah’s point of view, that Malaysian Islamic banks emerged from the global financial crisis relatively stable and unscathed is due to the regulatory framework that was put in place. "Malaysian banks found themselves totally isolated from the crisis because they had not been allowed to invest as much overseas after the Asian financial crisis."

• AAOIFI is expected to provide rules governing the entry into and exit from contracts that are Shari'ah-compliant. However, it is unclear at this time what this will mean.
  
• Central Bank of Bahrain Governor Rasheed Al Maraj is quoted from a dinner honoring Professor Simon Archer: "Many remain comparatively small and focused on niche markets. The result is that we have an industry that comprises many small-scale firms engaged in very similar activities and with comparatively high concentrations of risk. As I have said several times in the past, for the long-term health of the industry it is important to generate greater scale and diversity. [...] the events of the past few years should have given the industry a clear signal that it must reduce its reliance on real estate as an asset class [and] The industry should look instead at the scope for increasing the finance it provides for productive assets such as factories, ports, mines and oil processing facilities. Financing these activities may appear less profitable in the short-term, but may be a better proposition on a risk-adjusted basis." I agree.
  
• Islamic Finance Asia has a good article on the challenges to developing secondary market liquidity in sukuk.
  
• The IMF study on Islamic vs. conventional banks in the crisis has been released.
  
• A look back at the post-crisis (and especially post-Dubai debt crisis) dominance within the primary market for sukuk from Asia. A Bloomberg looks forward towards the potential issuance that could result from the 10-year, $444 billion Malaysian development plan.
  

Thursday bullets

• The head of Shari'ah and CEO of IIMF believe that greater transaction document standardization, like the Master Agreement on Treasury Placement released by IIFM, will benefit the industry.
  
• There are a number of articles on Khazanah's S$1.5 billion ($1.1 billion) sukuk, including from Bloomberg, AsiaOne News and and Reuters.
  
• The Deputy Governor of the Central Bank of Malaysia gave a speech at the 21st Conference of Presidents of Law Associations of Asia on Islamic finance. The full text is available as a pdf.
  
• Al Rajhi Investment and Banking Corporation Malaysia Bhd, a subsidiary of the Saudi Islamic bank Al Rajhi Bank joined the Bursa Suq Al-Sila', the commodity murabaha/tawarruq platform in Malaysia.
  
• An article offers a few details about the Family Bank Bahrain, an Islamic microfinance institution that is working with the Grameen Trust.
  
• An article published by Zawya, written by three lawyers at King & Spalding, covers the different trends in how Islamic financial products are taxed.
  
• BMB Islamic released its Global Islamic Finance Report 2010, which in addition to describing the industry's growth also acknowledges that there is a shortage of authentic data on the size, growth and performance of the institutions making up the industry.
  
• The Maldive's Monetary Authority issued the first Islamic banking license to Maldives Islamic Bank Pvt. Ltd.
  
• Bloomberg has another article about the potential for growth in sukuk issuance from Asia while the GCC primary markets are at their slowest pace since 2005.
  
• A commenter for the Guardian Michael Tomasky takes a look at Islamic finance and realizes that the hyperbolic charges leveled against it are ridiculous on further examination.
  
• An Islamic brokerage, Makaseb Islamic Financial Services, in Abu Dhabi is closing.
  
• Malaysian companies Axiata Group Bhd and Malaysia Airports Holding Bhd are planning RM4.2 billion ($1.3 billion) in 7-10 year sukuk and RM3.1 billion ($981 million) in sukuk of unspecified tenor, respectively. The bulk of the Axiata sukuk will be sold to the Employees Provident Fund.
  

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.
  

Rushdi Siddiqui interviews four scholars, sukuk update

First, thank you to those who have responded with feedback about a possible email newsletter of blog postings (and maybe other commentary). I would appreciate any other feedback, either as a comment to this post or in an email to blake@sharingrisk.org.

I think that Rushdi Siddiqui's latest article, an interview with four prominent Shari'ah scholars, Dr. Hussain Hamid Hassan, Dr. Mohammad Daud Bakar, Yousuf Talal DeLorenzo and Dr. Mohammad Akram Laldin is one of the most important articles for everyone interested in Islamic finance to read. It contains insights into how Shari'ah scholars see their role, the role of Shari'ah governance and the integration of younger less well-known scholars into the Shari'ah advisory role. It contains the most candid reflections of Shari'ah scholars that I have seen published about their own role both as advisors to Islamic financial institutions and as teachers and mentors of the Shari'ah scholars who will someday fill their shoes.

There is a good chunk of news about sukuk from the last couple days. The forward looking news starts with a $1.9 billion sukuk issued by Saudi Electric Company, which was issued at 95 basis points over SIBOR. As I wrote about in July 2009, the last sukuk from SEC was at a significant premium (160 bps over SIBOR) compared to it's (pre-crisis) sukuk issuance which was priced at 45 bps over SIBOR. The current sukuk is still at a premium to its 2007 sukuk, but by a far smaller margin. The shrinking yield premium for highly-rated issuers could lead to other non-high-grade corporate issuers to re-enter the sukuk market. The last estimate I have seen of the sukuk pipeline (sukuk planned but not issued) from Standard & Poor's was $50 billion, which likely includes lower rated corporates waiting for yield spreads for new issuance to decline.

Issues of sovereign sukuk, both domestically and internationally, remains active with Malaysia issuing a three-year, $311 million (MYR 3 billion) Sukuk 1Malaysia 2010 for domestic investors. In the wake of the Greek debt crisis, Indonesia is trimming but not cancelling the sukuk issuance expected in June or July of this year, but reiterated guidance that it would be a "benchmark" size, which typically means at least $500 million. The previous announcement was that the sukuk would be for $750 million. The Dubai Multi Commodities Centre just redeemed its $200 million, five-year sukuk issued in May 2005 with a final $20 million repayment. The certificateholders of Nakheel's $980 million Nakheel Development 2 sukuk have been told informally that the sukuk will be repaid on time. The funds necessary to repay the sukuk are reported to have been provided by the Dubai Financial Support Fund. This could spark some controversy among other Dubai World subsidiaries' creditors groups who have not yet finalized a debt restructuring which could see the other debt maturities extended and a 1% interest rate paid to creditors.

An article tackling the oft-debated issue of standardization in Islamic finance provides a very interesting view on the issue and what the current issues raised by tawarruq and the TID v. Blom Bank case. Reuters adds a factbox about the regulation of Islamic finance globally.

PricewaterhouseCoopers raises the issue, likely to confront Asian issuers of sukuk, about whether the illiquidity (and possible fluctuations) in their currencies will hamper the development of their Islamic finance appeal outside of the region. The issue has been confronted to some degree with Indonesia's dollar-denominated global sukuk issue last year and talk about a 10-year Malaysian dollar-denominated sukuk. There should remain a focus on developing domestic markets for Islamic finance, particularly within Indonesia where Islamic finance remains less developed. However, the internationalization of Islamic finance within Southeast Asia (and potentially South Korea, Japan and China) will strengthen the industry as a whole by providing additional geographical diversification for investors in dollar (and euro and pound and yen) denominated sukuk.

IFSB summit, Moody's weighs in on sukuk form versus substance, Sheikh DeLorenzo on Islamic home finance in the US

Moody's released a report looking at the future of the sukuk market with a suggestion that investors look not just at the form of the structure, but the substance as well. Although many sukuk use standard forms (as approved by AAOIFI), they can vary significantly across different individual sukuk using the same form. This is particularly important, Moody's notes, because "The assets in the structure are commonly there for Shari'ah compliance purposes only, and ultimately have no bearing on the risk or performance of the sukuk investments, particularly in a distress situation." This is an important point because it raises questions about whether the sukuk market has focused too much on structuring transactions to receive Shari'ah-compliance and too little on creating a different asset class.

There is an interesting opinion article written by Shari'ah scholar Sheikh Yusuf DeLorenzo describing the benefits from the Islamic home finance product in the US for both Muslims and non-Muslims. These benefits are due to the participatory structure of many forms of Islamic home finance in the US and the non-recourse nature of the loans. The combination of these two factors, according to Sheikh DeLorenzo, leads to a lower rate of foreclosure following delinquency because the Islamic finance companies can only take the house in a foreclosure and if this value is below the outstanding amount owed (the mortgage is 'under water'), the bank faces a loss. Although this is the case in many states for all mortgages, it is not always the case in conventional mortgages.

The IFSB says that Islamic finance regulators need to focus on the entire system instead of having a narrow focus on individual institutions to prevent a repeat of the current crisis facing the conventional financial industry in the Islamic finance industry. I think this is very important because there are fewer safeguards on the industry to prevent contagion from spreading from one troubled institution to healthy institutions, like inter-bank money market and a 'lender of last resort'. The president of the Islamic Development Bank Dr. Ahmad Mohamed Ali said at the IFSB summit that the industry still has a significant amount of innovation needed to continue its rapid growth. The head of the IFSB was also quoted speaking to the Straits Times: "It all comes down to risk management. You've to have proper risk management and proper governance and practices so that an institution doesn't fall down".

Bank Negara deputy governor is quoted speaking about two critical issues that the Islamic finance industry needs to deal with to become more resilient in the future:

"There are a lot of issues that need to be addressed, for example the link to economic activity also has got its shortcomings because they are too focused on real estate for example. The absence of a money market that is also a source of risk."

Other News

• France's new laws that put Islamic finance on equal footing with conventional financial institutions for taxes has attracted the first institution, the Islamic Finance Advisory and Assurance Services, a UK-based consultancy.
  
• There is an article in Foreign Policy magazine that I may have already linked to about Shari'ah scholars and the Islamic finance industry.
  
• The Islamic Development Bank is planning a $500 million sukuk in the first half of 2009. The proceeds will fund the IsDB's activities in member countries this year. This is the bank's first issue in a five-year bond program that aims to raise $1 billion per year. The Monetary Authority of Singapore expects $1.3 billion in sovereign sukuk issues from Singapore, Malaysia and Indonesia in the first half of 2009. The Monetary Authority of Singapore also unveiled measures to attract Islamic finance to the city-state including legal and regulatory changes that allow Singaporean dollar sukuk to be treated identically with conventional government bonds.
  
• Dubai Islamic Bank is going to buy back $200 million of its $750 million outstanding sukuk in a tender offer at between 86% and 90% of par. The Shari'ah-compliance of debt buybacks was not raised in the article. The sukuk last traded March 13 on the London Stock Exchange at 82. The buy back is therefore being offered between a 5% to 10% premium.
  
• RHB Islamic, the Malaysian bank, is expanding its business to Singapore and has applied for a full banking license in the country.
  
• Gatehouse Bank in the UK is setting up a Shari'ah-compiant investment strategy focused on the water industry with Sustainable Asset Management (SAM).
  
• Islamic mortage companies Amlak and Tamweel will receive "major government support" due to their losses caused by the collapsing property markets, increased funding costs and halt in financing.
  
• Fattah Finance, a Shari'ah-compliant brokerage subsidiary of Almaty Financial Centre, is the first Islamic finance company to open in Kazakhstan following the changes in law to allow Islamic finance. Mauritius' first Islamic bank, HSBC Mauritius Amanah, opened today.
  
• A Shari'ah manager at BMB Islamic provides an overview of the basic principles of Isalmic finance.
  

A lot of news about the sukuk market

Sukuk

Some analysts believe that greater regulation of the sukuk market is needed to attract foreign issuers like Malaysia has. The greater availability of daily prices of sukuk would also help to make the asset class more transparent and appealing to both issuers and investors.

Bahrain is planning a $500 million government sukuk issue to cover the deficits caused by the steep fall in oil prices in 2008. The Central Bank of Bahrain, which issues short-term Al-Salam and Al-Ijara sukuk is planning to issue five year sukuk of unspecified size and coupon.

GS Caltex Corp, a South Korean oil refiner, will become the first Korean issuer of sukuk when it completes its RM1 billion ($278 million) raise in Malaysia.

The London Review of Books has an article on Islamic finance that is generally interesting although not everything in it squares with reality.

The Turkish government sold Lira 737.8 million ($461.1 million) in "revenue-indexed bonds" which links the coupon payments to the government's share of revenue generated by state companies. The government planned on selling up to Lira 1.854 billion in the Islamic bonds that resemble musharaka. Although the maximum issue amount was not met, the proportion of the maximum that was issued was greater than the country's first issue in January 2009 where one-quarter of the planned issue of Lira 1.89 billion was purchased.

Malayia's Securities Commission chairman believes that only $10 billion in sukuk will be issued globally in 2009. This would be significantly below the level in 2008 which was well short of the total issued in 2007. The first quarter was weak but if credit markets in general and sukuk markets in particular unfreeze, there is a large pipeline of sukuk waiting to come to market. Islamic banks are more optimistic, expecting to see between $4 and $7 billion in sukuk from Southeast Asia alone.

Other News

The Dow Jones Islamic Market Index commentary for April is available.

Amlak and Tamweel, two Islamic mortgage lenders in Dubai, will begin lending as separate entities before the final plan that is likely to lead to a merger is announced. Prices in the property markets in Dubai fell over 40% in the first quarter of 2009 according to the Colliers International Housing Price Index.

AAOIFI will initiate a study about how the Islamic finance industry "adheres to its benchmarks with a view to standardizing products". They will seek to determine the degree of Shari'ah-compliance with the institution's 40 standards.

Standard & Poor's and Moody's came out with reports on the GCC and Asian sukuk markets, respectively and the general message was that the market conditions in global credit markets had hampered new issuance, but that the industry was well positioned to grow.

Moody's said: "Sovereign sukuk issuance has already brought significant vitality to the Asian market in 2009. In the medium term this could allow activity to fully rebound,"

S&P said: "We believe that the underperformance in sukuk issuance is due in large part to the effects of the global economic downturn, specifically its influence on capital market issuance in GCC states. We are of the view, however, that notwithstanding the current state of the financial markets, the GCC will be the focus of most infrastructure and project finance sukuk activity in the short to medium term. This is because sukuk funding structures provide an alternative to the traditional bank financing that shows no immediate signs of return in the currently dislocated financial markets."

Catch up from a busy week

• The Asian sukuk market has rebounded slightly in 2009 as a few sovereign issuers, including Indonesia and Malaysia's government and the Monetary Authority of Singapore have issued sukuk. There are a few other soverign sukuk issues planned this year that could include Tailand and China as well as additional issues from Singapore, the first issue by a government entity in Hong Kong and regular issuance by Malaysia.
  
• The 2009 budget for the UK includes taxation changes that provide relief for sukuk from stamp duty for the transactions involved in transferring land between the financer and the SPV. The government had considered issuing a sovereign sukuk, but those plans remain on hold but could come at the end of 2009 or beginning of 2010 at the earliest.
  
• A new provider of Islamic home finance was authorized by the FSA in the UK. The newest company is Pink Home Loans.
  
• Al Baraka Banking Group, the Bahraini-based Islamic bank that is spearheading the new mega-Islamic bank is planning to launch an Islamic bank in France. The CEO Adnan Yousif indicated on CNBC Arabiya that French regulators have expressed interest in the bank's plans to start an Islamic bank in France.
  
• The Central Bank of Bahrain issued BD6 million ($15.9 million) more Al-Salam 91 day maturity sukuk for which there were more than BD25m (a bid-to-cover ratio of 4.17).
  
• The Houston Chronicle has an article on Islamic home finance which also provides a criticism of the Islamic home finance from Dr. Mahmoud El-Gamal.
  

Sukuk volume in 2009: opinions differ

An English online grocery store Ocado received £10 million in financing using Shari'ah-compliant leasing (ijara). Although the transaction is small and uses a relatively simple Islamic finance product, it has significance, I think, because it is the company's first use of Islamic finance and it chose this type of finance because of the "competitive offering" from the Bank of London and the Middle East, a Shari'ah-compliant wholesale bank in the U.K. There are relatively few instances where Western companies chose Islamic finance products based on their price competitiveness (e.g., the $166 million East Cameron Gas Co. sukuk), but there is potential for this to become more common if Shari'ah-compliant banks are able to tap sources of capital and have not been hurt themselves by the credit crisis through the slowing of global growth where health companies find that they can only receive finance from conventional banks at extremely high cost.

According to a poll conducted by Reuters, the amount of sukuk expected to come from Southeast Asia, a region with a large volume of sukuk in recent years, is around $5 billion, far below last year. Most of the issuance is expected to be issued by governments. A previous estimate for Malaysia put the volume from that country at $4 billion for 2009. The GCC region is also expected to see far smaller volume of sukuk with unnamed bankers telling Reuters they expect to see issuance between $4 and $8 billion. Standard & Poor's, however, believes there are $45 billion of sukuk in the pipeline and the number that reach the market in 2009 will depend on whether the market becomes more favorable than it is now.

Other News

• Gatehouse Bank announced a new $1 billion 'Milestone Sukuk' platform and a first issue on the platform that it claims makes the issue of sukuk easier.
  
• Islamic financial institution Arcapita Bank, based in Bahrain and Atlanta, Georgia was downgraded recently, in part because of its 'high leverage'. The high leverage aspect is surprising because Islamic finance is often characterized as putting significant limits on allowable leverage.
  
• Turkey's first sukuk, a revenue-linked bond, was a flop raising only about one-quarter of the planned amount.
  
• Organizers of the 2009 Asia Sukuk Summit, in contrast, believe that countries where Islamic finance is just beginning to become into significance like Jordan, Hong Kong, Singapore and Japan will issue sukuk this year.
  

Islamic finance at risk from commodity price volatility

Although Islamic finance has grown rapidly over the past 8 years, it still is not widely accepted by high net worth individuals in Asia, some of whom are concerned that it does not have a long enough track record. One of the concerns is whether Islamic finance will be able to endure after oil prices fall back to lower prices. After reaching nearly $150 per barrel, they are now trading around $80 per barrel. A Forbes article describes in further detail the risks of falling real estate and commodity prices for Islamic finance. In addition to falling commodity prices, which lowers wealth growth in the GCC compounded by slowing real estate price growth, there is another hazard: commodity price volatility. The reason that commodity price volatility is harmful is that, whether you agree with it or not, there is widespread use of products like commodity murabaha. In transactions like commodity murabaha transactions to synthesize conventional loans are structured using trades in commodities (e.g. metals). Greater volatility in the prices of these metals introduces trading risk if the prices at which these metals can be bought and sold (often on the London Metal Exchange).

The second soverign sukuk planned by the Malaysian government will reset the risk-free pricing benchmark for ringgit denominated issues and facilitate price discovery of ringgit-denominated sukuk during the current market turmoil. The last Malaysian sovereign sukuk was issued over six years ago.

Japan Bank for International Cooperation (JBIC) may be forced to delay its sukuk issue because of the credit crisis.

I disagree with the comments from Sheikh Qaradawi about the 'collapse' of the western financial system and the presumption that Islamic finance provides a unique alternative that can stand on its own right out of the gate. Islamic finance provides a good model for how to expand ethical finance beyond just screening investments, but there are still several products that are warts on the Islamic finance industry like commodity murabaha and tawarruq. In these two cases, products are structured to mimic conventional interest-based loans to meet financial demands of Islamic banks and consumers where alternatives that are unique from conventional products have not yet been developed. Islamic finance should not be focused on standing alone apart from other ethically-based financial systems. Other ethical systems share similar concerns as Islamic finance about interest-based finance, funding weapons and other products which have a socially detrimental effect like alcohol and tobacco. The similarities should be praised and used as a way to promote a more just financial system not just one for Muslims.

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.

Indonesia, France need regulatory/tax changes to see growth in the next couple years in Islamic finance

Badlisyah Abdul Ghani, the CEO of Malaysian bank CIMB Islamic, writes in an opinion piece in the Jakarta Times, "The government's proposed issuing of rupiah and U.S. dollar sukuk are anticipated to provide a good benchmark for the Islamic debt capital market. With this benchmark in place, more corporations will be enticed to issue their own sukuk. To facilitate this, the government needs to develop a corporate sukuk law and the relevant Islamic securities guidelines." In addition he highlights the need to change tax laws to ensure "tax neutrality and transaction cost neutrality vis-a-vis conventional bonds".

Anouar Hassoune of Moody's writes about the future of Islamic finance at CPIfinancial. He discusses Islamic financial institutions and internationalization and consolidation, sukuk and the possibility to see an Islamic bank and a sovereign sukuk issue in France in the next two or three years if developments on the legal and regulatory side continue to progress.

A recent sukuk was issued in Abu Dhabi that securitized the receivables in an installment sale of property. It sounds like this creates a securitized murabaha transaction which appears to me to be difficult since the cash flow from a murabaha transaction does not represent a transfer in ownership of the underlying asset. The transfer of ownership in an asset (i.e. trade) is often the fundamental requirement for a transaction to be Shari'ah-compliant. Instead, from what is being reported, the sukuk will be a mudaraba where the sukuk holders are the rabb ul-mal (provider of capital) and the issuing company is the mudarib responsible for executing the business, in this case by collecting payments on land sales and selling any repossessed land. The profits from this will be shared between the issuer and sukuk holders. A Zawya story describes the methodology of the ratings agencies of the sukuk. IFLR describes the structure as well as why it is preferable to many other types of sukuk.

The continuing financial and economic problems in the West are leading to the growth in interest in Asia including through Shari'ah-compliant funds.

Brunei issued its 18th ijara sukuk of B$45 ($32.25 million) million bringing the total it has issued to B$1.2 billion ($862 million). The oil-rich sultanate does not need to issue any debt, but wants to encourage the growth of Islamic finance.

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.

Islamic finance needs tighter regulation to avoid future problems

Islamic finance, driven by economic growth in the GCC and Asia as well as high oil prices, still faces potential pitfalls from lack of product diversification and a lack of clearly understood regulatory treatment. The Dubai Financial Services Authority (DFSA) also recently warned that Islamic finance needs tighter standards to avoid some of the problems affecting conventional financial markets.

A Malaysian retakaful provider, MNRB Retakaful, plans further expansion into other regions including the GCC and South Africa. Shari'ah-compliant insurance and reinsurance is currently underdeveloped but predicted to see growth at a rate close to the Islamic finance industry as a whole.

HSBC plans to issue sukuk in Turkey once the regulatory & legal environment becomes accomodative.

Islamic finance growing globally, particularly in the GCC and U.K., although the industry is not completely immune from the credit crisis

The rapid growth in Islamic finance has begun to receive interest from Western financial institutions and others like rating agencies (e.g. Moody's and Standard & Poors), consulting companies (McKinsey) and news organizations (Financial Times and Bloomberg). This is a credit to the industry's rapid growth and potential to emerge from being a niche industry to one that could become significant in the global financial system. The Islamic financial industry is also expanding into Europe, particularly the U.K. (although there are many other cities vying to become a hub in the global Islamic financial industry) The Independent newspaper in the U.K. has an interesting article on the different Islamic financial products available in the U.K. A recent event called 'Microfinance in the Islamic world' was held at the House of Commons and featured a presentation by Muslim Aid, a charitable organization which has done a significant amount of Shari'ah-compliant microfinance. The conservative nature of Islamic financial products has increased their attractiveness as more risky products have run into problems recently.

The first multi-asset class investment fund was launched on the AIM in London last Friday trading under the ticker FSF.

France is continuing the process of figuring out legislative, tax and regulatory changes needed to rival London for the center of Islamic finance in Europe. Despite having a Muslim share of the population many times that of the U.K., Islamic finance is still nearly nonexistent in France. Switzerland, although prominent in international finance, has lagged behind on Islamic finance.

AAOIFI is developing a governance standard for corporate social responsibility. This is a very important step because it will provide a way to monitor whether Islamic financial institutions are meeting their ethical responsibilities that are the core of their differentiation from most conventional financial institutions.

The Indonesian rupiah-denominated sukuk will be placed in mid-August with a listing expected on August 27th. Doha Bank has delayed their planned $1 billion sukuk to develop an exchange for carbon emissions trading in the Middle East because of poor market conditions. Thai property developers should finance their businesses using sukuk, according to the former head of the Islamic Bank of Thailand Dheerasak Suwannayos. Since 2006, the growth in sukuk has outstripped the growth in conventional bond issues in the GCC, and almost half of this has financed real estate projects.

The Netherland Antilles are exploring legal and regulatory changes needed to attract Islamic finance.

Islamic economist Humayon Dar is working with a group called Charity Bank to develop Shari'ah-compliant financing for non-profit organizations in the U.K.

Dubai Islamic Bank recently launched a Shari'ah consulting group, Dar Al Sharia, to provide research and development and consulting services in Islamic finance transactions.

Islamic banks in the GCC are planning expansion into North Africa and Asia to find new opportunities to grow.

NPR has an article on Islamic home finance in the United States.

IBF Net is launching an institute studying Islamic microfinance in the state of Orissa in India. I have had the pleasure of speaking with one of the founders of the Institute of Microfinance and Development, Dr. Mohammad Obaidullah who is also a Senior Economist at the Islamic Development Bank, and I anticipate that they will make a very positive impact.

Islamic credit cards are becoming more available, although they differ little from conventional credit cards. Usually, the either offer a line of credit with a fee based on the amount used, a murabaha structure where the card issuer 'owns' the goods purchased for an instant when they are purchased and charge a markup, or a lease-buyback where they own the goods until they are paid for and 'lease' usage. They seem to be virtually indistinguishable from conventional credit cards in impact, more so than other Islamic finance transactions where there is a chance for the Islamic finance company to take ownership.

Credit crunch make sukuk more expensive, new IMF working paper on the soundness of Islamic banks

The total assets under management screened using Shari'ah screens in the GCC and Asia is now $267 billion, according to a report from Ernst & Young. The report also highlights the growth of the Shari'ah-compliant asset management industry noting that almost one-third of the 500 funds were established in 2007. In addition, the growth in Shari'ah-compliant funds is different in Malaysia and the GCC. In the former, there is greater pressure placed by investors on ensuring that Shari'ah-compliant products are competitive in returns with conventional funds, while in the GCC, Shari'ah-compliant funds are preferred to conventional funds, even if there are lower returns. Although the funds have seen greater geographical diversity recently, they are still limited in the asset class diversification, particularly to fixed income and real estate through REITS, which are typically highly leveraged and therefore do not pass Shari'ah screens that exclude investments with debt of more than 1/3 of assets.

Although Islamic banking is allowed in Turkey where it is called 'participation banking', it makes up a 'negligible' share of total banking assets and laws allowing sukuk have not been passed. Ten banks in Indonesia recently announced they are converting to Islamic banks and growth in Islamic banks exceeds that in conventional banks. However, the Islamic banking industry makes up a tiny portion of total bank assets and it will be a "struggle" to reach 5 percent of total bank assets according to the Deputy Governor of Bank Indonesia Siti Ch Fadjrijah. Dr. Muhammad Syafi Antonia of the Central Bank of Indonesia adds that "We have to see the Islamic instrument not from narrow base religious approach, but from a wider approach how to accelerate the growth and development of Indonesia". Ireland may be the next European country to see growth in Islamic finance, although official counts only show the Muslim population at 32,500. Malaysia's Securities Commission announced changes to the list of Shari'ah-compliant equities, adding 23 and removing 12.

Recent sukuk issuance have been denominated more in UAE dirhams, Saudi riyals and Malaysian ringgit because the credit crisis has caused dollar denominated sukuk to be more costly.

The Dinar Standard presents a summary and analysis of some of the themes covered at the recent Harvard Forum on Islamic Finance and adds the statement that Islamic economics needs "individuals with deep and sympathetic understanding of both Shariah and the fields of economics and finance, and a sincere desire to marry these together so that the product is more than the sum of the parts". The field is lacking, according to the author Dr. Athar Osama, academics of the caliber of "Adam Smiths, Maynard Keynes, and Irving Fishers".

Despite many opinions to the contrary, the credit crisis is having an effect on the Islamic financial industry by making sukuk more expensive for issuers. Several sukuk have been delayed because the returns expected by the investors (often linked to LIBOR) exceeds the return that issuers are willing to pay to receive financing. However, despite the added costs, there are likely to be between $12 and $18 billion in sukuk issued in 2008.

"The GCC/DIFX index tracks returns from Gulf Arab dollar sukuk over Libor, and was at 225.85 basis points more than the benchmark on May 23, up from 175 at the start of the year and more than three times pricing in June last year before the subprime crisis."

The Financial Times has an interesting interactive feature on their website about Islamic finance including a short discussion on the sukuk controversy and the Shari'ah-compliant versus Shari'ah-based question from Neil Miller, a lawyer at Norton Rose.

The IMF released a working paper and short article summarizing the paper that show that small Islamic banks are more sound than their conventional counterpoint, but that larger Islamic banks are less sound than either conventional commercial banks and smaller Islamic banks, possibly due to their greater reliance on profit-and-loss sharing (rather than fee based business). The paper did not find that the presence of Islamic banks does not impact the soundness of other banks in the financial system.

Moody's projects growth of Asian-originated sukuk, INCEIF conference

The issuance of sukuk originating in Asia should grow significantly over the next few years as sukuk begin to flow from India, Indonesia, Pakistan and Singapore, Moody's describes in a recent report.

The Malaysian Prime Minister Abdullah Badawi gave a speech at the INCEIF Global Forum in Kuala Lumpur in which he called for "new Islamic financial products" and looking "towards how to enlarge and strengthen Islamic financial institutions".

Speaking at the same conference, Prince Andrew spoke about how the "UK and Malaysia are pre-eminently well-placed to work together". An article describing the Prince's speech from the UK is available here.

Dr. Zeti Akhtar Aziz, central bank governor at the Bank Negara Malaysia, speaking at the INCEIF conference, described the need for efficiently priced Islamic finance products. One example she provided was pricing ijara sukuk using the rental rate of the underlying asset, which she concluded would lead to prices changing with supply and demand. Her criticism may have been motivated by recent price fluctuations in sukuk which mirrored changes in conventional bond prices as well as a common trend where sukuk returns are benchmarked to an interest rate, frequently the London Interbank Offered Rate (LIBOR).

KFH expansion, Malaysia, Indonesia, Turkey & Shari'ah scholars

Kuwait Finance House, the Kuwaiti Islamic bank, will expand within the Middle East to Saudi Arabia, Oman and Qatar and may also look to expand in Asia. Currently, KFH operates only in Malaysia. The expansion will be funded by the recent $1.06 billion share sale.

The number of Malaysian Islamic banks continues to grow even as the conventional sector works to consolidate. This article is also available from Business Times as a pdf file.

CIMB Islamic appointed Sheikh Nizam Yaquby to its Shari'ah Supervisory Board for the next two years. Sh. Yaquby is a member of over 40 Islamic financial institutions' Shari'ah boards. The company's investment banking business will also triple its Islamic private equity funds.

The DIFC listing of its $1.25 billion sukuk on the DIFC pushes the amount of sukuk over the $10 billion mark.

Central Bank of Bahrain governor Rasheed Al-Maraj believes the Islamic finance industry needs to acheive greater harmonization to succeed.

Indonesian's second largest lender, PT Bank Central Asia Tbk, plans to enter the Islamic finance industry through an acquisition of two smaller lenders.

Turkey's Islamic banks (participation banks) are growing rapidly.