The resurgence in sukuk issuance since the twin shock of the global financial crisis and the Dubai debt crisis has been nothing short of remarkable. One of the most surprising indicators of how much demand for sukuk has rebounded is that the Dubai sovereign sukuk--issued by the very sovereign that was at the center of a storm in December 2009--has seen its yield drop from 6.396% when it was issued to just 3.2% yesterday. There have been a few hiccups in the 'year of the refinance' (notably with Arcapita's $1.1 billion syndicated murabaha), but many new sukuk have been issued, including the largest sukuk in history, the $4 billion Qatari sovereign sukuk which priced to yield 2.1% which reportedly left enough buyers out that they flooded the secondary markets, bidding prices up.
The development of the Islamic repo market (as nascent as it may be) has likely also encouraged a few extra buyers for sukuk, since they can realize some liquidity from their sukuk holdings through Islamic repo that allows them to hold onto that sukuk. This is true in particular for investment-grade sukuk like Qatar's sovereign sukuk. At the same time, reports suggest Western investors are becoming interested again with sukuk, through both primary and secondary markets.
This is a good thing. More demand and better secondary market liquidity will help bring new issuers into the market to provide more supply to meet the demand, which is clearly growing. However, the rapidity with which the market has boomed should be a cause for some concern. There will undoubtedly be a break in trading activity once Ramadan begins, but after the Eid, will there continue to be the same confluence of financial market conditions to support the prices for sukuk?
Will Western investors return to Europe if there is a pathway to a solution of the Eurozone debt crisis? Will there be geopolitical tensions in the GCC that affect local investment demand in sukuk versus 'safe' assets like US Treasuries (since not all investments from that region are dedicated entirely to Shari'ah-compliant investment strategies)? These are always concerns for the market, but when it has risen as quickly as it has recently, the risk of something happening that spooks an already relatively illiquid market rise.
In the long-run, sukuk markets are likely to continue to grow as Islamic finance increases its share of the financial markets in the GCC, but that does not mean the growth will occur along a straight line. There will be rough patches (hopefully not as challenging as the last five years), but the demand for sukuk is robust and the more mature that market becomes, the more it is likely to attract new potential investors and issuers.
Showing posts with label Islamic repo. Show all posts
Showing posts with label Islamic repo. Show all posts
Wednesday, July 18, 2012
Sunday, July 08, 2012
Sukuk market development
As I was finishing up my weekly newsletter, I had a few extra thoughts to add to what I included in the newsletter. Here's a portion of the newsletter (sign up on the right hand side of the blog, old issues of the newsletter are available at the Sharing Risk website) for context:
I ran across a presentation from 2005 where the head of IIFM, Ijlal Alvi (PDF) lays out a broad prediction for sukuk markets (with a few recent relevant news items added):
- Increasing demand from issuers to tap sukuk markets (South Africa is planning to issue sovereign sukuk) IFIs want tradable sukuk with fixed income profile
- Development of sukuk funds followed by growing demand for sukuk, causing issuance to “surge exponentially” (Indonesian sukuk fund managers want to expand fund size, but fear demand for sukuk will outstrip supply. This is also true in Malaysia).
- Sukuk will be used for liquidity management and as a money market instrument. (IIFM held a meeting on collateralized murabaha with sukuk as collateral, which is rapidly becoming the standard alternative for unsecured commodity murabaha in inter-bank lending markets)
The items for the sukuk market to develop laid out by Mr. Alvi 7 years ago seem to be falling into line quite well, after being interrupted by the financial crisis. There is however, a key item missing in the sukuk markets across the items above: tradability is possible, but it remains limited.
What surprised me is how well articulated the needs for the sukuk market have been over several years when the global economy and financial markets have gone through significant changes. The problem for Islamic finance is not necessarily that the problems are not articulated, it is that there are so many different factors in play, and the sukuk market is not a unified market, so different markets around the world have a different set of items to change that have moved to the top of the list for stakeholders.
For example, the GCC is largely dominated by sovereign (and government-related entity) issuance, which probably mitigates some of the risks to coporate sukuks that are more common in Malaysia, but the GCC sukuk markets are relatively illiquid and dominated (in terms of size) by fewer, larger sukuk. The Malaysian market is more liquid, with a larger number of issuers, particularly corporate issuers, although there are a number of very large government- or GRE-issued sukuk (the difference is that the secondary market is better developed).
From the top-down perspective, the GCC would be served by a greater diversity of issuers, while Malaysia is attracting more buyers chasing the available sukuk that causes the market to become relatively more illiquid if holders of sukuk don't wish to part with their holdings in fear of not being able to find another sukuk to replace it. The discussion above itself is mostly from a high-level, and there are many other nuances that distinguish aspects of the sukuk markets in these regions and across the countries in the GCC.
However, with different needs in different markets, it is difficult to address the underlying difficulties to even accomplish and agreed-upon goal: creating an Islamic repo product. This is being adopted, using a collateralized murabaha structure, in both the GCC and Malaysia (the latter in part to provide GCC-connected banks with acceptable short-term liquidity management products as a substitute to the domestic inter-bank market which those banks won't use).
An Islamic repo product in order to remain viable even in periods of financial stress, need to have highly-rated and liquid collateral (an equivalent to US Treasuries for conventional repos). There is a shortage of this collateral, which is in part what the IILM will provide (if an inaugural sukuk is ever launched), will have to be issued in large enough supply and with enough diversification across the short end of the yield curve and across different currencies to get a secondary market developed. Otherwise, issuers will be forced to pick and choose from among the sukuk outstanding, which could lead to increased pricing distortions in the yields between liquid and illiquid sukuk as banks bid up the liquid sukuk to use for repo transaction.
So, while individual markets will have their own challenges to address, it is important for the Islamic finance industry to find areas where there are similar challenges--and solutions--to tackle in a cooperative way. One of these challenges is liquidity management and the solution, which is on the right path even if it is taking far too long, is the IILM.
Saturday, May 26, 2012
The "Immunity" Myth, debunked by the IFSB
"At the IFSB, we share in the general assessment that Islamic finance
has been resilient to the global crisis, but Islamic finance has not
escaped the crisis and it is certainly not immune to it." - IFSB Secretary General Jaseem Ahmed
The IFSB held its 9th summit in Istanbul and Secretary General Ahmed laid out a few goals in his speech, but I think most critically for the industry gave the above quote that effectively renounces the widely parroted view that Islamic finance is somehow immune from crisis. This is important because the view that Islamic finance is immune from crisis (or even from the most recent financial crisis) is one of the damaging viewpoints for the industry's development. It is critical that the Islamic finance industry recognize that it is connected intimately with the global economy (including the conventional financial industry).
Islamic finance must learn from the failures of the conventional finance industry lest it repeat the failures, especially since it already has been swept into the crisis with the massive real estate boom in Dubai that became speculative and led to its own crisis. It is true that the Dubai property boom was fueled in large part by conventional financial institutions, but Islamic finance was not immune from the greed-fueled run-up.
One need only to remember that the trigger for the entire Dubai debt crisis was the likely inability of Nakheel to repay a massive sukuk that came due in December 2009. I wrote about the prospects for the holders of that sukuk at the time and noted that, although it was guaranteed by Dubai World (unlike the other Nakheel sukuk) there was no direct sovereign recourse, making repayment unlikely without a bailout.
That bailout of course did come, from Abu Dhabi, which loaned Dubai $10 billion to repay, in part, the $3.52 billion Nakheel sukuk. The important point in rehashing the Nakheel sukuk bailout is to remember what the sukuk was financing (or at least the asset underlying the sukuk). It was a strip of desert that was envisaged to become a huge development (and the value of its appraisal was based on these plans). After the near-default, Nakheel struggled to craft a resolution for its creditors, a high point in the crisis in my mind since most of the claims were adjudicated by a tribunal made up of foreign judges under the laws of the DIFC (which are based on English law).
However, for trade creditors, the situation was not quite as predictable since they were paid partly in cash but partly with a sukuk backed by land under the Persian Gulf. Essentially they were given a back-door version of a (now) common 'extend-and-pretend' refinancing which gives some remedy (you might get some repayment, just not now), but also avoids the type of public restructuring that Arcapita is now engaged in (I personally favor the route forced on Arcapita since it gives more transparency).
Circling back from a rather long digression, the next step from the admission by the Secretary General of IFSB that Islamic finance is not immune from crisis is to develop a reaction to the next crisis, whether that crisis hits just one institution or the global economy. The first order of business is to consider the idea of how bankruptcy or other resolution for failed institutions could work (a primer on the implications of bankruptcy of a Shari'ah-compliant financial institution are described in a paper by Michael McMillen).
The next is to continue the focus of developing tools for Islamic finance institutions to avoid reaching a Lehman moment, since bankruptcy for financial institutions outside of a formal resolution process can turn messy and lead to contagion. The keys for avoiding cascading failures is to have short-term liquidity management tools that are not tied up in the perceptions of solvency of a counterparty that doomed Lehman when times turned bad.
The best solution for Islamic financial institutions would be to have a robust liquidity management system that offered both nearly risk-free assets like those that will eventually be issued by the International Islamic Liquidity Management Corporation (backed by many counties' central banks) and repurchase (repo) facilities in each country that will allow Islamic financial institutions to borrow against the IILM-issued assets. Let's all thank the IFSB Secretary General for stating a point which is clear to all of us who paid attention to the financial crisis, but which was ignored by people who continued to describe Islamic finance as 'immune' from crisis, and get to work on making Islamic finance as robust as possible against future crises.
The IFSB held its 9th summit in Istanbul and Secretary General Ahmed laid out a few goals in his speech, but I think most critically for the industry gave the above quote that effectively renounces the widely parroted view that Islamic finance is somehow immune from crisis. This is important because the view that Islamic finance is immune from crisis (or even from the most recent financial crisis) is one of the damaging viewpoints for the industry's development. It is critical that the Islamic finance industry recognize that it is connected intimately with the global economy (including the conventional financial industry).
Islamic finance must learn from the failures of the conventional finance industry lest it repeat the failures, especially since it already has been swept into the crisis with the massive real estate boom in Dubai that became speculative and led to its own crisis. It is true that the Dubai property boom was fueled in large part by conventional financial institutions, but Islamic finance was not immune from the greed-fueled run-up.
One need only to remember that the trigger for the entire Dubai debt crisis was the likely inability of Nakheel to repay a massive sukuk that came due in December 2009. I wrote about the prospects for the holders of that sukuk at the time and noted that, although it was guaranteed by Dubai World (unlike the other Nakheel sukuk) there was no direct sovereign recourse, making repayment unlikely without a bailout.
That bailout of course did come, from Abu Dhabi, which loaned Dubai $10 billion to repay, in part, the $3.52 billion Nakheel sukuk. The important point in rehashing the Nakheel sukuk bailout is to remember what the sukuk was financing (or at least the asset underlying the sukuk). It was a strip of desert that was envisaged to become a huge development (and the value of its appraisal was based on these plans). After the near-default, Nakheel struggled to craft a resolution for its creditors, a high point in the crisis in my mind since most of the claims were adjudicated by a tribunal made up of foreign judges under the laws of the DIFC (which are based on English law).
However, for trade creditors, the situation was not quite as predictable since they were paid partly in cash but partly with a sukuk backed by land under the Persian Gulf. Essentially they were given a back-door version of a (now) common 'extend-and-pretend' refinancing which gives some remedy (you might get some repayment, just not now), but also avoids the type of public restructuring that Arcapita is now engaged in (I personally favor the route forced on Arcapita since it gives more transparency).
Circling back from a rather long digression, the next step from the admission by the Secretary General of IFSB that Islamic finance is not immune from crisis is to develop a reaction to the next crisis, whether that crisis hits just one institution or the global economy. The first order of business is to consider the idea of how bankruptcy or other resolution for failed institutions could work (a primer on the implications of bankruptcy of a Shari'ah-compliant financial institution are described in a paper by Michael McMillen).
The next is to continue the focus of developing tools for Islamic finance institutions to avoid reaching a Lehman moment, since bankruptcy for financial institutions outside of a formal resolution process can turn messy and lead to contagion. The keys for avoiding cascading failures is to have short-term liquidity management tools that are not tied up in the perceptions of solvency of a counterparty that doomed Lehman when times turned bad.
The best solution for Islamic financial institutions would be to have a robust liquidity management system that offered both nearly risk-free assets like those that will eventually be issued by the International Islamic Liquidity Management Corporation (backed by many counties' central banks) and repurchase (repo) facilities in each country that will allow Islamic financial institutions to borrow against the IILM-issued assets. Let's all thank the IFSB Secretary General for stating a point which is clear to all of us who paid attention to the financial crisis, but which was ignored by people who continued to describe Islamic finance as 'immune' from crisis, and get to work on making Islamic finance as robust as possible against future crises.
Sunday, May 13, 2012
Shari'ah risks are not the only risks to Islamic repo
Repurchase agreements, also called repos, are a common way for conventional banks to manage liquidity needs or to lend out surplus liquidity. By doing so, the banking industry is able to manage its liquidity in a way that, at least in theory, does not create systemic risks. This is because a repo transaction is a form of secured lending so that even if the counterparty in the repo transaction goes out of business, the lender can recover the amount lent by liquidating the securities provided as collateral.
The International Islamic Financial Market released a paper exploring the different options for a Shari'ah-compliant version of the repo transaction used by conventional banks. The paper, which I discussed in a newsletter and in a blog post, had several possible methods for an Islamic repo, but the most likely to be used in practice is likely the collateralized murabaha structure. A few using the collateralized murabaha have been executed in the market, but there is still not nearly enough agreement on the structure for it to become as commonplace as repos are in the conventional banking industry.
The National Bank of Abu Dhabi seems to be leading the charge into using the collateralized murabaha structure, since it first executed a one-week $20 million Islamic repo with Abu Dhabi Islamic Bank. However, moving forward in $20 million or even $100 million increments will not put the Islamic repo into common usage anywhere close to the levels of conventional repos (even when viewed in terms of relative size compared with total assets in the Islamic banking system).
Part of that is that it is new, and any new product will start out being used by one institution and other banks will only adopt it gradually. However, based on the Reuters article describing the discussions at the AAOIFI conference, the entire structure is still facing an uphill climb to gain industry-wide approval from various Shari'ah boards regarding some of the issues associated with the transactions (for example, margin interest and netting exposures by setting off positions against other transactions in similar amounts in the opposite directions).
These are thorny issues, but as the idea of an Islamic repo gains market acceptance, there will be other weightier issues around the systemic risks from repos that will arise outside of the current discussion over Shari'ah issues with repos. Specifically, if you return to remembering why a collateralized murabaha repo would be an improvement for the industry, it is because the collateralization protects the lenders in the transactions from default by the counterparty since in the case of default they can always sell off the collateral to recover the amount lent.
The collateralized murabaha repo would presumably give the lender the same right, which would improve on the current commodity murabaha inter-bank lending (which is unsecured). In the current state, lenders are likely to be more attuned to the risks that their counterparties default since their loans are backed only by the full faith and credit of the counterparty to repay the principal plus profit. There is no asset they could take ownership of and liquidate so Islamic banks would or should be more hesitant to engage in inter-bank lending with institutions at risk of failing.
They will be much faster at denying interbank credit to the very banks that need the funding the most to stay solvent and avoid a liquidation of their assets in a fire sale, which could turn a liquidity crunch into insolvency for the bank (which is where the systemic issues begin if the panic spreads to the banks who had been lending to the troubled one). A secured inter-bank financing market based on collateralized murabaha repos will make Islamic banks more likely to continue to lending to one another even if one becomes troubled since the lender will have the collateral to protect its financing interest in the counterparty.
The point where a risk remains is "what is the collateral?". Most conventional repos are backed by government or quasi-government debt and so in most times banks can be assured that there will be a stable market with a ready bid if it ever needed to seize and liquidate the collateral. The same cannot be said for most sukuk. There is, in the best of times, a thin market for sukuk and any troubles for the issuers of sukuk lead to sharp sell-offs.
When sukuk are used as collateral, the lending bank will require a haircut based on the strength of the sukuk issuer and the liquidity of the market for that sukuk, which introduces an inefficiency that, by requiring a higher degree of overcollateralization, will limit the potential for Islamic repos to replace unsecured commodity murabaha inter-bank lending. Or else, participants in the Islamic repo market will ignore the risks that the collateral itself can play in the repo transaction as a whole, which is perhaps a worse outcome.
The Shari'ah issues probably will be resolved to provide an Islamic repo structure that is accepted widely, mostly out of the need for such a product. However, the systemic issues underlying the growth in Islamic repo that uses risky collateral will not be addressed as easily. However, it is incumbent on the industry to recognize these risks, and while the adoption of international financial and accounting standards like the Basel standards should force this issue to the forefront for each institution, it should be another reminder of the importance of ensuring a large supply of high-grade sukuk with a liquid secondary market behind it.
The International Islamic Financial Market released a paper exploring the different options for a Shari'ah-compliant version of the repo transaction used by conventional banks. The paper, which I discussed in a newsletter and in a blog post, had several possible methods for an Islamic repo, but the most likely to be used in practice is likely the collateralized murabaha structure. A few using the collateralized murabaha have been executed in the market, but there is still not nearly enough agreement on the structure for it to become as commonplace as repos are in the conventional banking industry.
The National Bank of Abu Dhabi seems to be leading the charge into using the collateralized murabaha structure, since it first executed a one-week $20 million Islamic repo with Abu Dhabi Islamic Bank. However, moving forward in $20 million or even $100 million increments will not put the Islamic repo into common usage anywhere close to the levels of conventional repos (even when viewed in terms of relative size compared with total assets in the Islamic banking system).
Part of that is that it is new, and any new product will start out being used by one institution and other banks will only adopt it gradually. However, based on the Reuters article describing the discussions at the AAOIFI conference, the entire structure is still facing an uphill climb to gain industry-wide approval from various Shari'ah boards regarding some of the issues associated with the transactions (for example, margin interest and netting exposures by setting off positions against other transactions in similar amounts in the opposite directions).
These are thorny issues, but as the idea of an Islamic repo gains market acceptance, there will be other weightier issues around the systemic risks from repos that will arise outside of the current discussion over Shari'ah issues with repos. Specifically, if you return to remembering why a collateralized murabaha repo would be an improvement for the industry, it is because the collateralization protects the lenders in the transactions from default by the counterparty since in the case of default they can always sell off the collateral to recover the amount lent.
The collateralized murabaha repo would presumably give the lender the same right, which would improve on the current commodity murabaha inter-bank lending (which is unsecured). In the current state, lenders are likely to be more attuned to the risks that their counterparties default since their loans are backed only by the full faith and credit of the counterparty to repay the principal plus profit. There is no asset they could take ownership of and liquidate so Islamic banks would or should be more hesitant to engage in inter-bank lending with institutions at risk of failing.
They will be much faster at denying interbank credit to the very banks that need the funding the most to stay solvent and avoid a liquidation of their assets in a fire sale, which could turn a liquidity crunch into insolvency for the bank (which is where the systemic issues begin if the panic spreads to the banks who had been lending to the troubled one). A secured inter-bank financing market based on collateralized murabaha repos will make Islamic banks more likely to continue to lending to one another even if one becomes troubled since the lender will have the collateral to protect its financing interest in the counterparty.
The point where a risk remains is "what is the collateral?". Most conventional repos are backed by government or quasi-government debt and so in most times banks can be assured that there will be a stable market with a ready bid if it ever needed to seize and liquidate the collateral. The same cannot be said for most sukuk. There is, in the best of times, a thin market for sukuk and any troubles for the issuers of sukuk lead to sharp sell-offs.
When sukuk are used as collateral, the lending bank will require a haircut based on the strength of the sukuk issuer and the liquidity of the market for that sukuk, which introduces an inefficiency that, by requiring a higher degree of overcollateralization, will limit the potential for Islamic repos to replace unsecured commodity murabaha inter-bank lending. Or else, participants in the Islamic repo market will ignore the risks that the collateral itself can play in the repo transaction as a whole, which is perhaps a worse outcome.
The Shari'ah issues probably will be resolved to provide an Islamic repo structure that is accepted widely, mostly out of the need for such a product. However, the systemic issues underlying the growth in Islamic repo that uses risky collateral will not be addressed as easily. However, it is incumbent on the industry to recognize these risks, and while the adoption of international financial and accounting standards like the Basel standards should force this issue to the forefront for each institution, it should be another reminder of the importance of ensuring a large supply of high-grade sukuk with a liquid secondary market behind it.
Tuesday, April 03, 2012
Malaysia's Security Commission-OCIS forum details shared
I was critical recently about the Malaysian Securities Commission and the Oxford Centre for Islamic Studies holding a closed door forum, then issuing a press release about it with few details. Whether or not it was in response to my post, I was nonetheless happy to see a more complete discussion in the Malaysian International Islamic Financial Centre (MIFC) email newsletter. I have posted it below. As I said in the post, transparency is important in Islamic finance and, while it does not have to be applied in every case (there are valid reasons for not everything to be disclosed all the time, but usually in those cases there is not a press release issued), it can benefit everyone to bring discussion on the big issues in Islamic finance into the public view.
I think there are some very interesting ideas proposed, not all of which are new, but which need to be repeated until they are addressed. In particular, I think that Neil Miller's comments on sukuk secondary markets should be a focus in liquidity management (as Ijlal Alvi mentioned when discussing the use of sukuk as collateral in tri-party repo). There are a lot of areas in the sukuk market that need development, and among the points that the summary describes from Neil Miller, the most important in my opinion is adding depth and breadth to the sukuk market (an issue I have discussed several times, including one rough estimate at the potential for sukuk issuance in the GCC if it reached the size relative to the economy as Malaysia, and if corporate issuers in the GCC became more active).
There can be little development in sukuk markets and in sukuk-backed repo transactions if there are not enough sukuk issued. In order to develop trading markets, there should also be a variety of sukuk (many different issuers, tenors, ratings, etc) to make it more worthwhile for investors to sell one type in order to buy another (to move from lower to higher quality, or from a longer to shorter maturity).
There are many thought provoking questions raised, even in the short article about the forum, but having the subjects revealed publicly should start many more discussions than the original press release will.
I think there are some very interesting ideas proposed, not all of which are new, but which need to be repeated until they are addressed. In particular, I think that Neil Miller's comments on sukuk secondary markets should be a focus in liquidity management (as Ijlal Alvi mentioned when discussing the use of sukuk as collateral in tri-party repo). There are a lot of areas in the sukuk market that need development, and among the points that the summary describes from Neil Miller, the most important in my opinion is adding depth and breadth to the sukuk market (an issue I have discussed several times, including one rough estimate at the potential for sukuk issuance in the GCC if it reached the size relative to the economy as Malaysia, and if corporate issuers in the GCC became more active).
There can be little development in sukuk markets and in sukuk-backed repo transactions if there are not enough sukuk issued. In order to develop trading markets, there should also be a variety of sukuk (many different issuers, tenors, ratings, etc) to make it more worthwhile for investors to sell one type in order to buy another (to move from lower to higher quality, or from a longer to shorter maturity).
There are many thought provoking questions raised, even in the short article about the forum, but having the subjects revealed publicly should start many more discussions than the original press release will.
Solutions for Liquidity Management in Islamic Finance The Securities Commission Malaysia (SC) and the Oxford Centre for Islamic Studies (OCIS) organized the 3rd SC-OCIS Roundtable which was held at the Securities Commission, Kuala Lumpur on 12-13 March 2012. The theme for this year's Roundtable was 'Solutions for Liquidity Management'.
The Roundtable had three main sessions each comprising two presentations, two respondents and Questions & Answers and a Chairman. There was also an opening session with keynote speeches and a concluding session where Chairs summed up the proceedings of each respective session and made recommendations on 'Solutions for Liquidity Management' going forward.
The session topics included 'Reaching Consensus on Sukuk Trading'; 'Developing Participatory Instruments as Liquidity Tools'; and 'Commodity Murabahah and its Variants' respectively. For the benefit of MIFC Community members and EPICENTRE readers, this Briefing highlights the main issues and conclusions that were discussed during this closed-door Roundtable.
The Session on 'Reaching Consensus on sukuk Trading' saw two robust presentations - one by Neil Miller, Global Head of Islamic Finance, KPMG, Dubai, who highlighted several constraints in sukuk trading and suggested some solutions which would help overcome some of these constraints to achieve liquid markets; and the other by Ijlal Alvi, CEO, International Islamic Financial Market (IIFM), Bahrain, who proposed the use of sukuk as a form of collateral at both a domestic and cross-border level, and the development of a Three-party Islamic alternative to repurchase contracts (REPOs) based on the principle of l'aadat Al Shira'a - the lack of which is considered a major impediment in the development of an Islamic inter-bank market.
Neil Miller suggested several solutions for sukuk trading to develop further:Ijlal Alvi alluded to various AAOIFI standards which allow for the addition of extra collateral. On this basis he suggested the use of sukuk as a form of collateral. He highlighted the following considerations:
- A need for a steady supply of liquid securities with different risk profiles and maturities - in other words more depth and breadth in the market;
- The emergence of cross-border liquidity framework;
- Greater integration of Islamic financial centres to promote a vibrant secondary market;
- A regulatory environment that promotes meaningful disclosure and transparency;
- The establishment of a bespoke trading platform to facilitate the listing and subsequent trading of a wide universe of sukuk and other Shariah-compliant instruments; and
- The inclusion of built-in controls in the proposed Platform to prevent the market from misusing the trading of sukuk or controlling junk sukuk trading.
The Session on 'Developing Participatory Instruments as Liquidity Tools' comprised presentations by M Iqbal Asaria, Associate Afkar Consulting Ltd and Visiting Faculty, CASS Business School, UK and Rushdi Siddiqui, Global Head, Islamic Finance & OIC Countries, Thomson Reuters.
- Understanding the Shariah issues, for instance under the Shariah collateral must be in kept in a separate account;
- Taking security, where under the Shariah it is not possible to rehypothecate securities as practiced in conventional banking;
- Margin maintenance and accounting treatment; and
- The establishment of an International Triparty Agent which he said was essential to be developed in Islamic finance jurisdictions.
Iqbal Asaria warned against the debt-based market fundamentalism that spurred the growth of the West. Islamic finance grew within this debt based system, creating pressure for Islamic banks to replicate and mimic the conventional products. He questioned the current state of Islamic finance which is still plagued by lack of standardisation, continued use of Inah and Dayn, the growth of Tawarruq and Commodity Murabahah. There is little progress in cross-border liquidity and challenges relating to Basel III. He urged among others; Islamic finance should move towards equity oriented financing, Islamic finance should use the sukuk experience to develop and participatory instruments such as Corporate Musharakah Certificates.
Rushdi Suddiqi on the other highlighted the need for sophistication and efficiency in the commodity murabahah platform in the areas of such as news data , central counterparty clearing entity, greater use of electronic processes and the introduction of a screen-based platform for trading.
The session on 'Commodity Murabahah and its Variants' comprised presentations by Associate Professor Dr Said Bouheraoua, Chief Academic Officer and Dean, International Shariah Research Academy for Islamic Finance (ISRA) Malaysia, and from Khairul Nizam, Assistant Secretary General, Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), Manama.
The conclusions were that:
- Commodity Murabahah is acceptable to manage solutions in liquidity management of an Islamic bank despite varying Shariah views;
- AAOIFI recognises Tawarruq subject to pre-conditions and that regulated Tawarruq is an alternative such as the Bursa Suq al-Sila' platform;
- It is imperative to have mutual recognition on Shariah positions amongst jurisdictions to facilitate cross-border transactions to facilitate liquidity management;
- Liquidity management is intended to preserve the 'health' of the Islamic banking system that will allow Islamic banks to serve the society/public and this is consistent with the objectives of the Shariah (Maqasid al-Shariah); and
- There should be much greater cooperation and contact between market practitioners, Shariah scholars and economists in addressing the above issues.
Saturday, February 11, 2012
GACA sukuk is repo-eligible and has a zero risk weighting
It sounds like the GACA sukuk (issued by the Saudi aviation authority and backed by the government) could indeed spark a more liquid sukuk secondary market in the country with the sukuk being able to be used in repo transactions (unclear whether these would be Shari'ah-compliant repo transactions or repos by conventional banks using the sovereign sukuk as collateral).
However, the zero percent risk weighting (from the Saudi Arabian Monetary Authority (SAMA)) could lead many financial institutions to hold onto the sukuk to maturity, or to not necessarily trade it actively. However, I think that the size of the sukuk ($4 billion) should give the hold-to-maturity investors enough supply while leaving enough available for investors to buy and sell when they want to sell or buy corporate sukuk, giving the prospects for the Tadawul (where I would expect it to be listed) to become a much more liquid sukuk secondary market.
As I have written earlier, I am not usually impressed by the "biggest" or "first" qualifier for sukuk, but I think this one ("it is also billed as the largest sovereign guaranteed issuance in emerging markets in the last ten years" and is also the first Saudi sovereign sukuk) is different because it could lead to follow-on offerings from other agencies in the Saudi government, as well as by corporate issuers who might be drawn in if the secondary market becomes sufficiently liquid to provide a reliable benchmark.
However, the zero percent risk weighting (from the Saudi Arabian Monetary Authority (SAMA)) could lead many financial institutions to hold onto the sukuk to maturity, or to not necessarily trade it actively. However, I think that the size of the sukuk ($4 billion) should give the hold-to-maturity investors enough supply while leaving enough available for investors to buy and sell when they want to sell or buy corporate sukuk, giving the prospects for the Tadawul (where I would expect it to be listed) to become a much more liquid sukuk secondary market.
As I have written earlier, I am not usually impressed by the "biggest" or "first" qualifier for sukuk, but I think this one ("it is also billed as the largest sovereign guaranteed issuance in emerging markets in the last ten years" and is also the first Saudi sovereign sukuk) is different because it could lead to follow-on offerings from other agencies in the Saudi government, as well as by corporate issuers who might be drawn in if the secondary market becomes sufficiently liquid to provide a reliable benchmark.
Wednesday, January 25, 2012
The Social Impact of Islamic Finance
Farooq Sheikh, a student at the Lahore University of Management Sciences, wrote a 2 part series for SocialFinance, a Canadian blog on impact investing ([Part 1] [Part 2]). In a comment, he clarifies what he meant by 'social impact':
I am hopeful that Islamic finance will become more focused on the social impact of their activities, instead of just creating the easiest products for them to get Shari'ah approval and make a profit (while donating any non-permissible income to charity as their 'social impact'). There is definitely a wide range of Islamic financial institutions, so to some degree, statements about their concern about social impact are generalizations, but I think it is clear that most Islamic financial institutions are pre-occupied with acting as much like banks as they can.
As much as it may have been the intent of Islamic economists for "money has no intrinsic value and hence cannot be treated as the subject-matter of trade. It is just a medium of exchange. Islamic financing is always based on tangible assets and inventories, unlike its conventional counterparts." There is a significant question about whether this is the case in most transactions, for example, those based on commodity murabaha or tawarruq. These transactions involve tangible assets, but the assets are involved to create a debt (through sale with deferred payment).
For a while I have argued that this use of commodity murabaha is necessary, both to fit within regulatory requirements, but also in areas like liquidity management where other products do not exist. I think this is the case, but without necessarily disagreeing with the idea for Islamic finance that Sheikh described. This, I think, is a clear area where one can differentiate between different uses of commodity murabaha. While I generally support commodity murabaha used for inter-bank money market transactions (though I have critiqued the use of commodity murabaha-based repo transactions collateralized by commodity murabaha-based certificates of deposit), I have been critical of the use of the same structure for deposits.
The difference, I think, is whether there are alternatives that would work as well that are not commodity murabaha. In the case of Islamic repos collateralized by Islamic CDs, the commodity murabaha structure could be maintained for the repo with the collateral being tradable contracts like ijara. In the case of deposits, there are a number of other deposit products like wadiah, qard and mudaraba which are widely used by Islamic banks. It doesn't necessarily address the social impact of Islamic finance, but it can help to combat cynicism that Islamic banks always take the path of least resistance in terms of diverging from the way conventional banks do business.
"I am referring to an influence which is beneficial to the society and delivers sustainable social and/or environmental benefits without negatively affecting the social fabric in the area one is operating. It means solving the problems of the society (e.g. Providing equity financing to a project which would spur employment) and at the same time earning financial return on the capital for those who have provided the capital."
I am hopeful that Islamic finance will become more focused on the social impact of their activities, instead of just creating the easiest products for them to get Shari'ah approval and make a profit (while donating any non-permissible income to charity as their 'social impact'). There is definitely a wide range of Islamic financial institutions, so to some degree, statements about their concern about social impact are generalizations, but I think it is clear that most Islamic financial institutions are pre-occupied with acting as much like banks as they can.
As much as it may have been the intent of Islamic economists for "money has no intrinsic value and hence cannot be treated as the subject-matter of trade. It is just a medium of exchange. Islamic financing is always based on tangible assets and inventories, unlike its conventional counterparts." There is a significant question about whether this is the case in most transactions, for example, those based on commodity murabaha or tawarruq. These transactions involve tangible assets, but the assets are involved to create a debt (through sale with deferred payment).
For a while I have argued that this use of commodity murabaha is necessary, both to fit within regulatory requirements, but also in areas like liquidity management where other products do not exist. I think this is the case, but without necessarily disagreeing with the idea for Islamic finance that Sheikh described. This, I think, is a clear area where one can differentiate between different uses of commodity murabaha. While I generally support commodity murabaha used for inter-bank money market transactions (though I have critiqued the use of commodity murabaha-based repo transactions collateralized by commodity murabaha-based certificates of deposit), I have been critical of the use of the same structure for deposits.
The difference, I think, is whether there are alternatives that would work as well that are not commodity murabaha. In the case of Islamic repos collateralized by Islamic CDs, the commodity murabaha structure could be maintained for the repo with the collateral being tradable contracts like ijara. In the case of deposits, there are a number of other deposit products like wadiah, qard and mudaraba which are widely used by Islamic banks. It doesn't necessarily address the social impact of Islamic finance, but it can help to combat cynicism that Islamic banks always take the path of least resistance in terms of diverging from the way conventional banks do business.
Friday, December 23, 2011
Bank Indonesia reverse repo
Bank Indonesia (BI) extended its reverse repo operations to government sukuk on December 1st. The structure of the transactions are not clear, but based on another article and a BI regulatory document (which is not available in English, so I had to rely on GoogleTranslate) it looks like a wa'd-based repo transaction. In the past, the sukuk issued by BI were based on ijara (mitigating concerns about the Shari'ah-compliant of trading at prices different from par if it were repo on sukuk based on commodity murabaha).
However, the repo concept has been tricky to synthesize in a Shari'ah-compliant way, so the BI reverse repo would be a novel transaction. It appears that the structure is based on wa'd, a unilateral undertaking to purchase or sell. In the repo transaction (which the article said would be with a 1 month maturity, although that may only be used as an example), BI would sell a sukuk to a bank for the market value (assume for simplicity this is par, 100). The bank would make a unilateral undertaking to sell the sukuk bank to BI in one month for 100 plus a spread based on a repo rate of 4.6% annualized.
I think, although I am not familiar enough with the Shari'ah-compliance rules on wa'd to say for certain, that because it is only a unilateral promise, it is permissible to specify a price for the transaction in the future. If there were two unilateral promises (one by the bank to sell and one by BI to purchase), it would not be permissible. Presumably since BI is originating the transaction and is the central bank, it is virtually assured that it would purchase the securities without needing to give a binding promise.
One area where difficulty would arise is if the sukuk rose in price during the repo, for example to 120. The rules for the reverse repo transaction stipulate that if the bank decides not to honor its unilateral promise to sell, BI will charge the bank a penalty of the difference between the market price (i.e. 120) and the amount that the the bank bought the sukuk (i.e. 20). This appears to me to be a sticky point for Shari'ah-compliance, although it could be mitigated if the penalty were stipulated to be donated to charity. Anyway, with the penalty being stipulated as being the profit the bank would realize by not honoring its unilateral promise (removing the financial incentive for the bank to default), it is unlikely that this would ever occur in practice.
I think this is an interesting idea and I would like to see more documentation about how it works and also the logic by which it was approved by the Shari'ah board advising BI. I would appreciate any reader comments on the structure, since I am trying to piece together the structure from limited information, some of which I had to base on imperfect translations.
However, the repo concept has been tricky to synthesize in a Shari'ah-compliant way, so the BI reverse repo would be a novel transaction. It appears that the structure is based on wa'd, a unilateral undertaking to purchase or sell. In the repo transaction (which the article said would be with a 1 month maturity, although that may only be used as an example), BI would sell a sukuk to a bank for the market value (assume for simplicity this is par, 100). The bank would make a unilateral undertaking to sell the sukuk bank to BI in one month for 100 plus a spread based on a repo rate of 4.6% annualized.
I think, although I am not familiar enough with the Shari'ah-compliance rules on wa'd to say for certain, that because it is only a unilateral promise, it is permissible to specify a price for the transaction in the future. If there were two unilateral promises (one by the bank to sell and one by BI to purchase), it would not be permissible. Presumably since BI is originating the transaction and is the central bank, it is virtually assured that it would purchase the securities without needing to give a binding promise.
One area where difficulty would arise is if the sukuk rose in price during the repo, for example to 120. The rules for the reverse repo transaction stipulate that if the bank decides not to honor its unilateral promise to sell, BI will charge the bank a penalty of the difference between the market price (i.e. 120) and the amount that the the bank bought the sukuk (i.e. 20). This appears to me to be a sticky point for Shari'ah-compliance, although it could be mitigated if the penalty were stipulated to be donated to charity. Anyway, with the penalty being stipulated as being the profit the bank would realize by not honoring its unilateral promise (removing the financial incentive for the bank to default), it is unlikely that this would ever occur in practice.
I think this is an interesting idea and I would like to see more documentation about how it works and also the logic by which it was approved by the Shari'ah board advising BI. I would appreciate any reader comments on the structure, since I am trying to piece together the structure from limited information, some of which I had to base on imperfect translations.
Tuesday, November 15, 2011
IILM delays first sukuk issue
The International Islamic Liquidity Management Corporation (IILM) has delayed its first sukuk issuance according to Zeti Akhtar Aziz, the chairwoman of the IILM and head of Malaysia's central bank. She said that the first issuance would come in the next six months, while previous statements had said issuance would occur before the end of 2011. However, progress is being made with a rating forthcoming. The first issuance would be small, with follow-on issuance in the range of $2-$3 billion per issue in several currencies to meet demand, although in the past the IILM has stated that issuance would begin in US dollars and be followed by Euro issues with other currencies added as they were demanded by Islamic financial institutions.
The key function that the IILM provides is short-term sukuk, issued by a body with a high credit rating to meet the liquidity needs of Islamic banks. Banks generally take in short-term deposits and use those funds to lend long-term. To remain in business, they need to have sufficient liquidity (i.e. cash) on hand to meet withdrawals by depositors. The rating on the short-term assets they hold is important for meeting their minimum capital requirements under Basel and local regulations. The short-term sukuk provide an investment option that will generate some yield without exposing the banks to the counterparty risk that would emerge from inter-bank murabaha, for example.
There is also the potential, particularly if the IILM extends the maturities of sukuk it sells, for these sukuk to form the backbone for repurchase agreements (repos). A repo is a secured short-term (often overnight) loan between banks and in the conventional world operates using high quality bonds as collateral like US Treasuries. In the Islamic form of repos in use today in the UAE, the collateral is commodity murabaha-based certificates of deposit issued to banks by the UAE central bank, of which I have been critical. The International Islamic Financial Market (IIFM) has laid out other alternatives, none of which are optimal, for Islamic repos, which I described in an earlier post.
The next piece of information that will be interesting will be the assets that are used to back the issuance, and Zeti said they are working to "get the allocation of high-quality underlying assets". The most likely structure will be istithmaar or ijara, both of which would probably be done using an asset-based structure. The assets would likely be contributed by IILM members, most of which are central banks from OIC countries, although the Central Bank of Luxembourg is a member. The central banks are not likely to risk that their assets could be taken by sukuk holders should the IILM default or otherwise fall apart.
It is good to see the IILM move towards beginning operations, however late its development is. The biggest need it can fill is to provide a source of short-term assets for Islamic banks that do not have the risks associated with lending their surplus funds to other Islamic banks. When an Islamic bank lends its funds to another bank--even for a short period--it subjects itself to the risk that the funds would be lost or tied up if that bank failed. For the Islamic banking system as a whole, this provides a powerful mechanism for contagion, where the fears about an Islamic bank's solvency could be transmitted to other institutions which have lent money to it.
The key function that the IILM provides is short-term sukuk, issued by a body with a high credit rating to meet the liquidity needs of Islamic banks. Banks generally take in short-term deposits and use those funds to lend long-term. To remain in business, they need to have sufficient liquidity (i.e. cash) on hand to meet withdrawals by depositors. The rating on the short-term assets they hold is important for meeting their minimum capital requirements under Basel and local regulations. The short-term sukuk provide an investment option that will generate some yield without exposing the banks to the counterparty risk that would emerge from inter-bank murabaha, for example.
There is also the potential, particularly if the IILM extends the maturities of sukuk it sells, for these sukuk to form the backbone for repurchase agreements (repos). A repo is a secured short-term (often overnight) loan between banks and in the conventional world operates using high quality bonds as collateral like US Treasuries. In the Islamic form of repos in use today in the UAE, the collateral is commodity murabaha-based certificates of deposit issued to banks by the UAE central bank, of which I have been critical. The International Islamic Financial Market (IIFM) has laid out other alternatives, none of which are optimal, for Islamic repos, which I described in an earlier post.
The next piece of information that will be interesting will be the assets that are used to back the issuance, and Zeti said they are working to "get the allocation of high-quality underlying assets". The most likely structure will be istithmaar or ijara, both of which would probably be done using an asset-based structure. The assets would likely be contributed by IILM members, most of which are central banks from OIC countries, although the Central Bank of Luxembourg is a member. The central banks are not likely to risk that their assets could be taken by sukuk holders should the IILM default or otherwise fall apart.
It is good to see the IILM move towards beginning operations, however late its development is. The biggest need it can fill is to provide a source of short-term assets for Islamic banks that do not have the risks associated with lending their surplus funds to other Islamic banks. When an Islamic bank lends its funds to another bank--even for a short period--it subjects itself to the risk that the funds would be lost or tied up if that bank failed. For the Islamic banking system as a whole, this provides a powerful mechanism for contagion, where the fears about an Islamic bank's solvency could be transmitted to other institutions which have lent money to it.
Saturday, June 25, 2011
UAE central bank offering Islamic repo
The UAE central bank, which recently launched Islamic certificates of deposit to help Islamic banks manage their short-term excess liquidity needs is being expanded into a full repo (repurchase agreement) offering. I will discuss the structure in a little more depth (as much as I can based on the information now available), but the first point I find interesting is that it would be based on one model proposed in a paper by the International Isalmic Financial Market released last year, which I reviewed on my blog at the time it was released.
The structure that Reuters is reporting is being used is one based on murabaha. There is nothing new about commodity murabaha being used for liqudity management, but the repo product would use commodity murabaha with the central bank's Islamic CDs being offered by the bank as collateral for the loan. There are currently AED12 billion ($3.27 billion) in Islamic CDs held by Islamic banks in the UAE, giving a relatively large pool of assets for the repo transactions to use as collateral.
The need for a repo facility is clear for both central banks and Islamic banks, but the model that will be used is the most cynical possible outcome. When I read the IIFM report last year, I commented on the collateralized murabaha: "The addition of transfer of securities as collateral (without compensation) on top of the use of commodity murabaha would raise the most objections, I believe, on grounds that the product is cynical and does nothing to really help the industry develop new products." At that time, I saw the collateralized commodity murabaha as cynical because, although it tries to find a solution to a problem, it does so by further entrenching commodity murabaha into the Islamic financial industry.
The UAE repo facility goes one step further. Not only does it use the collateralized commodity murabaha between the Islamic banks and the central bank, it uses as collateral an Islamic CD which itself is based on commodity murabaha between the central bank and an Islamic bank. So, if an Islamic bank has surplus capital, it can loan it to the central bank by buying an Islamic CD, in which it buys a commodity and sells that commodity to the central bank and the central bank will repay the debt sometime within the next year (depending on the agreed upon maturity). However, if the Islamic bank needs liqudity before the CD matures, it can pledge that debt owed by the central bank to the central bank in exchange for a loan structured as a commodity murabaha.
If one takes this a step further and the central bank finds a way to have enable 'netting' of the commodity murabaha products, then it will have developed a way to trade debt (final payment for commodity murabaha represent a debt), which is mostly (outside of Malaysia at least) viewed as not permissible. As much as the short-term liquidity management tools are needed for Islamic banks (and for the central banks that want to engage in open market operations), creating a system where the central bank and Islamic banks are trading back and forth debts from commodity murabaha seems like the worst possible way to find a solution that has any lasting impact on the Islamic finance industry besides just solving the problem of the hour.
The UAE Central Bank has two PDFs describing:
-The Islamic CD; and,
-The collateralized commodity murabaha.
The structure that Reuters is reporting is being used is one based on murabaha. There is nothing new about commodity murabaha being used for liqudity management, but the repo product would use commodity murabaha with the central bank's Islamic CDs being offered by the bank as collateral for the loan. There are currently AED12 billion ($3.27 billion) in Islamic CDs held by Islamic banks in the UAE, giving a relatively large pool of assets for the repo transactions to use as collateral.
The need for a repo facility is clear for both central banks and Islamic banks, but the model that will be used is the most cynical possible outcome. When I read the IIFM report last year, I commented on the collateralized murabaha: "The addition of transfer of securities as collateral (without compensation) on top of the use of commodity murabaha would raise the most objections, I believe, on grounds that the product is cynical and does nothing to really help the industry develop new products." At that time, I saw the collateralized commodity murabaha as cynical because, although it tries to find a solution to a problem, it does so by further entrenching commodity murabaha into the Islamic financial industry.
The UAE repo facility goes one step further. Not only does it use the collateralized commodity murabaha between the Islamic banks and the central bank, it uses as collateral an Islamic CD which itself is based on commodity murabaha between the central bank and an Islamic bank. So, if an Islamic bank has surplus capital, it can loan it to the central bank by buying an Islamic CD, in which it buys a commodity and sells that commodity to the central bank and the central bank will repay the debt sometime within the next year (depending on the agreed upon maturity). However, if the Islamic bank needs liqudity before the CD matures, it can pledge that debt owed by the central bank to the central bank in exchange for a loan structured as a commodity murabaha.
If one takes this a step further and the central bank finds a way to have enable 'netting' of the commodity murabaha products, then it will have developed a way to trade debt (final payment for commodity murabaha represent a debt), which is mostly (outside of Malaysia at least) viewed as not permissible. As much as the short-term liquidity management tools are needed for Islamic banks (and for the central banks that want to engage in open market operations), creating a system where the central bank and Islamic banks are trading back and forth debts from commodity murabaha seems like the worst possible way to find a solution that has any lasting impact on the Islamic finance industry besides just solving the problem of the hour.
The UAE Central Bank has two PDFs describing:
-The Islamic CD; and,
-The collateralized commodity murabaha.
Monday, February 28, 2011
An Islamic repo coming to market
The National Bank of Abu Dhabi announced that it will launch a murabaha-based Islamic repo (repurchase agreement) product in March. I believe this would be the first Islamic repo. The few details in the article suggest that it is similar to the structure proposed as most likely by the International Islamic Financial Market (IIFM) . That structure (and likely the NBAD structure) essentially create a secured commodity murabaha contract. The two parties engage in a commodity murabaha transaction (sale of a commodity with deferred repayment), but unlike a normal murabaha transaction, the borrower pledges a pool of sukuk to secure the repayment.
This transaction is not terribly innovative on its face. The main difference between this transaction and a commodity murabaha is the pledge of sukuk as collateral. There are other add-ons that could be part of the transaction. For example, the transaction could be structured so that the buyer (lender) can re-hypothecate the sukuk (i.e. use it for its own purposes, including by using it to engage in repos with other counterparties). This would differentiate the repo from commodity murabaha transactions because it ties up assets of the bank for the length of the transaction.
The downside of the repo transaction is that it further limits the potential for secondary market liquidity in sukuk because holders of sukuk will use the repo market as an alternative way to make their holdings liquid. Thus, they will be less likely to offer their sukuk holdings in the secondary markets that are already limited in the supply of sukuk being offered. The flip side of this is that it could benefit the primary markets for sukuk because investors (depending on the quality of the issuer) would be able to generate liquidity from longer-term sukuk than they can today. It could also reduce any illiquidity premium that is priced into current sukuk offerings, which would make sukuk more competitive with conventional bond offerings.
The one area of caution that the article raises is that repo transactions were used by Lehman Brothers to clean up (manipulate) its balance sheet at the end of each quarter (window dressing). By "selling" assets around the date when financial information is reported and using the proceeds of the loan (which was classified as a sale and thus not debt) to pay down debt, it was used by Lehman Brothers to reduce the level of indebtedness reported in its financial statements. This is certainly a possibility within Islamic finance, but the lending contracts are more cumbersome, raising the cost of repaying and reborrowing debt. However, the real lesson is that the practice (called Repo 105 and Repo 108 by Lehman Brothers) should be discouraged by regulatory bodies.
The details of the specific NBAD Islamic repo are not yet known, but can be guesstimated based on the IIFM paper on possible structures. Islamic repos--particularly if the pledged sukuk cannot be re-hypothecated--will not do much to reduce the reliance on commodity murabaha, but it can increase the liquidity management options available for Islamic banks, which should (given enough controls to prevent abuse) make Islamic banks more stable. One of the secondary effects could be a reduction in the spread between conventional bonds and sukuk, which could increase the appetite by issuers to choose sukuk. This on its own could help the secondary markets because investors might shed their hold-to-maturity outlook, at least those investors who maintain that attitude because of a shortage of replacement sukuk in either the primary or secondary markets.
This transaction is not terribly innovative on its face. The main difference between this transaction and a commodity murabaha is the pledge of sukuk as collateral. There are other add-ons that could be part of the transaction. For example, the transaction could be structured so that the buyer (lender) can re-hypothecate the sukuk (i.e. use it for its own purposes, including by using it to engage in repos with other counterparties). This would differentiate the repo from commodity murabaha transactions because it ties up assets of the bank for the length of the transaction.
The downside of the repo transaction is that it further limits the potential for secondary market liquidity in sukuk because holders of sukuk will use the repo market as an alternative way to make their holdings liquid. Thus, they will be less likely to offer their sukuk holdings in the secondary markets that are already limited in the supply of sukuk being offered. The flip side of this is that it could benefit the primary markets for sukuk because investors (depending on the quality of the issuer) would be able to generate liquidity from longer-term sukuk than they can today. It could also reduce any illiquidity premium that is priced into current sukuk offerings, which would make sukuk more competitive with conventional bond offerings.
The one area of caution that the article raises is that repo transactions were used by Lehman Brothers to clean up (manipulate) its balance sheet at the end of each quarter (window dressing). By "selling" assets around the date when financial information is reported and using the proceeds of the loan (which was classified as a sale and thus not debt) to pay down debt, it was used by Lehman Brothers to reduce the level of indebtedness reported in its financial statements. This is certainly a possibility within Islamic finance, but the lending contracts are more cumbersome, raising the cost of repaying and reborrowing debt. However, the real lesson is that the practice (called Repo 105 and Repo 108 by Lehman Brothers) should be discouraged by regulatory bodies.
The details of the specific NBAD Islamic repo are not yet known, but can be guesstimated based on the IIFM paper on possible structures. Islamic repos--particularly if the pledged sukuk cannot be re-hypothecated--will not do much to reduce the reliance on commodity murabaha, but it can increase the liquidity management options available for Islamic banks, which should (given enough controls to prevent abuse) make Islamic banks more stable. One of the secondary effects could be a reduction in the spread between conventional bonds and sukuk, which could increase the appetite by issuers to choose sukuk. This on its own could help the secondary markets because investors might shed their hold-to-maturity outlook, at least those investors who maintain that attitude because of a shortage of replacement sukuk in either the primary or secondary markets.
Thursday, August 19, 2010
Thursday bullets
- The first Sukuk ALim was issued by Cagamas for RM1 billion ($317 million) with a yield of 3.48% and a three-year tenor. 43% of the issuance was subscribed by overseas investors including one-third from the Gulf. The structure was jointly created with the Malaysian unit of Al Rajhi Bank to conform to both Malaysian and GCC Shari'ah-compliance standards. It was 2.7 times oversubscribed.
- An article in Reuters discusses the push to close the gap between Malaysia and the GCC in Islamic finance.
- Sukuk yields have continued to fall in the face of uncertainty about the global economy, with yields falling to lower levels in Malaysia versus the GCC.
- Afghanistan is planning to issue Islamic banking licenses for three Islamic banks, the first in the country.
- Gulf Finance House said it had recorded a net loss in the first half of 2010 of $47.7 million compared to $92.1 million in the same period during 2009. Reuters calculated that the second quarter net loss was $39.9 million compared with a loss of $54.4 million in the second quarter of 2009. As part of its restructuring plan it reduced its assets from $2.7 billion at the end of 2009Q2 to $1.4 billion at the end of 2010Q2.
- Barclays Capital began offering Islamic repos during the past couple weeks. The structure was not discussed in the Bloomberg article.
- The Islamic Bank of Britain's shareholders approved the capital injection from Qatar International Islamic Bank of GBP20 million ($31 million).
- Kuveyt Turk issued a $100 million, 3-year sukuk, the first in the country. The government issued "revenue-indexed bonds" that are similar to sukuk in early 2009.
- A fund manager in Guernsey, Argyll Investment Services, launched its World Shariah Funds PCC Ltd.
- Indonesia delayed its sovereign sukuk for up to $650 million until 2011 because of lower budget deficits. The country's central bank is reviewing whether to approve changes to rules that would allow Islamic banks to restructure loans that are current. Current rules restrict restructuring to loans that are non-performing.
- The chairman of the World Islamic Economic Forum Foundation, Musa Hitam, was on a global version of CNBC (video) talking about where Islamic finance stands today.
- A conference on Islamic finance in Jeddah will suggest that there be a database of "permanent fatwas". Presumably, this would include fatawa on the most common Islamic finance structures.
Tuesday, August 17, 2010
Islamic foreign exchange forward contracts; halal participation banking?
Malaysian scholar Shamsiah Mohamad, who is a member of the Securities Commission Shariah Advisory Council, said that muwa'adah is a valid contract for foreign exchange contracts. Muwa'adah is a mutual promise in forward foreign exchange contracts and has been ruled impremissible by AAOIFI. The trading of currencies in forward markets is viewed as prohibited because currencies (taking the analogy from trading of gold and silver, which were used as dinar and dirham coins) must be traded only in the spot market. The distinction made with muwa'adah by the scholar is that the forward trade is a promise, not a contract because "it is not a sale and purchase contract because specific words must be used to enter into a contract in Islam". The controversy emerges because AAOIFI has ruled that the transaction (the binding mutual promises) does represent a contract and therefore cannot be used for foreign exchange futures contracts. It is one more example that the fiqh surrounding financial matters is still evolving in many areas and--whether it leads to positive or negative outcomes for the industry--it does represent an area of uncertainty in Islamic finance.
Rushdi Siddiqui's latest article in Gulf News deals with whether Islamic banking needs a rebranding. I have heard him speak a number of times and he has articulated the need to move beyond the 'Islamic' brand and the use of Arabic names for contracts to become more 'familiar' or 'accessible'. In his article, he ends with a combination of two ideas for Islamic banking: 'Halal Participation Banking', which combines the idea of that which is halal (which has been successful in the food industry) with participation banking, the name for Islamic banking in Turkey. I think it will be difficult to change the description of Islamic banking as 'Islamic', but that should not deter anyone from trying. In particular, the use of "participation" as a descriptor of the Islamic banking system is a good one in my opinion because it represents a reminder that Islamic banking differentiates itself as one where 'risk sharing' is an important idea. It may be used in practice less often as many Islamic financial products have replicated conventional financial products, but it provides a more clear explanation of how Islamic finance is designed to differ from conventional finance. It is also a phrase which can more easily convey the difference (in theory) with conventional finance and can be more easily be grasped by non-Muslims who may agree with the ideas of Islamic finance without even realizing it because of the use of Arabic terms and the 'Islamic' or 'Shari'ah-compliant' label.
Other News
Rushdi Siddiqui's latest article in Gulf News deals with whether Islamic banking needs a rebranding. I have heard him speak a number of times and he has articulated the need to move beyond the 'Islamic' brand and the use of Arabic names for contracts to become more 'familiar' or 'accessible'. In his article, he ends with a combination of two ideas for Islamic banking: 'Halal Participation Banking', which combines the idea of that which is halal (which has been successful in the food industry) with participation banking, the name for Islamic banking in Turkey. I think it will be difficult to change the description of Islamic banking as 'Islamic', but that should not deter anyone from trying. In particular, the use of "participation" as a descriptor of the Islamic banking system is a good one in my opinion because it represents a reminder that Islamic banking differentiates itself as one where 'risk sharing' is an important idea. It may be used in practice less often as many Islamic financial products have replicated conventional financial products, but it provides a more clear explanation of how Islamic finance is designed to differ from conventional finance. It is also a phrase which can more easily convey the difference (in theory) with conventional finance and can be more easily be grasped by non-Muslims who may agree with the ideas of Islamic finance without even realizing it because of the use of Arabic terms and the 'Islamic' or 'Shari'ah-compliant' label.
Other News
- South Africa has a proposal to modify its tax laws to place Islamic finance on equal footing with conventional footing by treating the profits in Islamic finance in a way equivalent with its treatment of interest in conventional transactions.
- The latest Central Bank of Bahrain Sukuk al-Ijara was oversubscribed 630% with BD63 million in subscriptions received for the BD10 million ($26.5 million) issue.
- Abu Dhabi Commercial Bank issued the first sukuk in its RM3.5 billion ($1.1 billion) sukuk program for RM500 million at 4.75%.
- Bloomberg has an article about the IIFM report on Islamic repos, which I discussed after it was released.
- An article describes the potential of Islamic finance in Russia and adds that state-controlled VTB Bank, which has had a sukuk in the pipeline for several years, will issue its sukuk for $200 million in the second half of the year, citing a Reuters report from April.
- Dubai's oldest Islamic bank, Dubai Islamic Bank, reported lower income in its second quarter financial report. It did not reveal its exposure to Dubai World. DIB owns 20% of Tamweel, the troubled Islamic mortgage company, and Deyaar, a Dubai-based property developer. Tamweel, which is in merger talks with Amlak Finance, another Islamic mortgage company in Dubai, reported positive income for the most recent quarter.
- A takaful provider, Dar Altakaful, launched a takaful policy for horse owners if their animal dies or becomes injured.
- An article in Bloomberg discusses the growth of Islamic investing in Malaysia with the entrant recently of international companies like Saturna Capital, the parent company of the Amana Funds in the U.S.
- Gulf Finance House is planning to raise additional capital--the second time in less than a year--and has delayed reporting its results.
- Ithmaar Bank reported its first results as an Islamic retail bank since its reorganization with its former subsidiary Shamil Bank.
- Bahrain Financial Harbour Holding Company repaid a $134 million sukuk.
Tuesday, August 03, 2010
IIFM Repo Report
In my weekly newsletter (subscription form on the left side of the screen) for the past week, I wrote about the idea of Shari'ah-compliant repos before I had a chance to read the IIFM report. As such, I focused mostly on the criticism I could foresee about the effort. As I mentioned, I think that the repo product is important enough to overcome the objections of replicating conventional products because the lack of similar products to repos limits Islamic banks' liquidity management by forcing them to hold excess cash which provides no return. The other side of the coin is that without Shari'ah-compliant short-term liquidity management instruments, it makes Islamic banks potentially more susceptible to large depositor withdrawals forcing a firesale of assets in an otherwise solvennt institution.
In the newsletter, I wrote:
The first concept is a bilateral repo (I'aadat Al-Shira'a or 'IS'). It is the closest to a conventional repo. Two parties agree to a sale by one party in the spot market with a repurchase of an identical (although not necessarily the original) security at a later date at a set price. The set price (not dependent on the market price at the time of repurchase raised issues of riba with the Shari'ah considerations with the scholars they asked. The use of an identical (part of the same offering) rather than the original security was generally accepted as avoiding the problem of debt trading (bai' al-inah).
The second concept changed the purchase undertaking to a wa'd (unilateral undertaking to purchase or sell), but raised more Shari'ah issues that the authors said would be "difficult to overcome". As a result of the difficulties associated with bilateral repos ('IS'), the third concept abandoned the bilateral structure for a three-party structure, which is different from the conventional tri-party repo.
The three-party structure inserted a third party in between the two parties with a sale to the third party by the 'borrower' and a purchase from the third party by the 'lender'. There was also a purchase undertaking for a specified price between the 'borrower' and the 'lender' to return the securities for a pre-specified sale price at maturity of the repo agreement.
The issues in the three-party repo were covered more extensively than in bilateral repo, which suggests that the three-party repo is a more preferable model, at least from the perspective of the report's authors. There remain significant financial and accounting issues concerning margin calls, overcollateralization, accounting treatment of the repos. From a Shari'ah perspective, there are issues with the purchase undertaking, specifically whether it can be exercised by the lender (to force repurchase by the borrower) or whether it is a unilateral promise (wa'd) by the borrower to the lender.
In my opinion, the issues highlighted by the authors are valid and it will be difficult to create a three-party repo that has the substance of a repo transaction (and be acceptable to both parties, regulators and accounting bodies) while avoiding the pitfalls mentioned from the Shari'ah perspective. The sale and purchase transaction at the outset is in the spot markets and is probably acceptable (although if the transaction were overcollateralized, there might be issues). However, the purchase undertaking for securities raises issues that are much more difficult. If the purchase undertaking were unilateral (not binding on the borrower), then it would in essence be a call option, which would not be acceptable for the lender. If the values of the securities fell, the borrower would just abandon them to the lender (let the call expire) and the lender would be left with a loss. In the conventional setting, most repos are conducted using highly secure and highly liquid bonds (like US Treasuries) and the use of overcollateralization or haircuts can mitigate this risk to the lender (as can the enforceability of the repurchase agreement). However, these are not possible in the Islamic repo transaction.
The final concept outlined is one that is essentially a modified commodity murabaha transaction. As in a commodity murabaha transaction, the lender buys a commodity and sells it with deferred repayment to the borrower. Unlike a straight commodity murabaha, the repayment obligation is secured by the sukuk held by the borrower (and overcollateralized to cover fluctuations in the value of the collateral). If the repayment is made on schedule, the sukuk are not sold and is returned to the borrower. If there is a default, the lender takes possession of the sukuk and can sell them to recoup the unpaid repayment. There are a number of issues that were encountered in the three-party repo (margin maintenance, accounting treatment and Shari'ah issues) as well other issues as whether the securities held as collateral could be re-hypothecated (i.e. used by the bank holding the collateral in its own business).
The final concept uses the most similar structure to Islamic short-term liquidity management instruments used today, but if re-hypothecation were allowed, it would be the most 'replicated' product structure. The addition of transfer of securities as collateral (without compensation) on top of the use of commodity murabaha would raise the most objections, I believe, on grounds that the product is cynical and does nothing to really help the industry develop new products. With the three-party repo at least, there would be a purchase and sale of the securities and the obligation created by the wa'd (purchase undertaking) would be based on another purchase of securities, however difficult the Shari'ah and financial issues it presents are.
None of the four proposed methods are perfect and as I described in my newsletter, that was likely from the outset. However, by providing an overview that describes the benefits and the limitations and Shari'ah-compliance issues involved with each, I think that the authors of the IIFM report have done a great service. Not only were the issues laid out, they were done so publicly. While it may receive criticism as being an exercise in replication of a conventional product for the Islamic financial industry, this degree of transparency can only serve to start debate about what alternative structures could be used. For example, would it be more worthwhile for other central banks to follow the lead of the Central Bank of Bahrain and begin issuing short-term (non-tradable) securities like the sukuk al-salam? Is the Malaysian example instructive (it is probably a non-starter on Shari'ah grounds in the GCC)? However, now that four suggestions have been laid out, the burden is on the critics to propose a solution that addresses the need by the Islamic banking industry, moves away from commodity murabaha and wakala and offers a better solution than has been proposed. With the level of talent working in Islamic finance and a shared desire to create a better liquidity management tool for the Islamic financial industry, I believe this is just the first step on the road to a solution to the problem at hand.
In the newsletter, I wrote:
"I have not yet had time to read over the IIFM report on Shari'ah-compliant repurchase agreements (repos). However, I am sure it will be viewed negatively in some respects with an argument made that the repos are just another example of Islamic finance replicating conventional financial products. The argument is valid in some respects. In a repo transaction one party borrows money by selling a debt with an agreement to repurchase at a higher cost at some specified point in the future. The transactions are generally short maturity debts, even if the underlying bond being sold and repurchase is of longer maturity (usually Treasuries or some other highly liquid investment).Having had a chance now to read the report, I think that my comments were correct. It could be viewed as an attempt to replicate repos in a Shari'ah-compliant structure, but the benefits from making short-term tools like Islamic repos available will ultimately benefit the Islamic financial industry. The report covers four concepts that were described and alludes to a fifth that is currently under discussion.
By that definition, there would seem to be several issues that are worked around that would make a repurchase agreement not Shari'ah-compliant. There is trading in debt, interest payments, and a forward contract on a debt at a specified price; all of which would make a traditional repo agreement not Shari'ah-compliant. The new structuring will likely replicate the outcome through a different Shari'ah-compliant structure. In the past with other transactions, that usually leads to criticism."
"The criticisms usually neglect the difficulty of developing an alternative to conventional finance working within a financial, legal and regulatory system that was developed with only the conventional financial system in mind. As such, it is hard to create an industry that competes with conventional finance and works within the financial system and so replication of conventional products--while not necessarily desirable long-term--do provide the Islamic financial industry with a starting point and as it develops further there will be changes that seek to improve it."
"The argument that product replication is desirable is not clearer in my view than for the case of repos and other short-term liquidity management tools. These allow banks to invest more of their capital (rather than holding it in cash), which makes them more competitive with conventional financial institutions while also increasing the stability of Islamic financial institutions by increasing the liquidity of their balance sheet. So long as their counterparties in repo transactions believe they are solvent, they will be able to manage withdrawals of deposits without being forced into a firesale of their assets. There are always potential areas where problems can arise like the Lehman Brother's Repo 105, which manipulated the bank's assets to make it look more healthy than it was and this could become a problem with Islamic repos. However, as long as sufficient controls are put in place by regulators, the benefit from greater ability for banks to manage liquidity will outweigh the criticism of just another highly structured conventional product with a structure that makes it Shari'ah-compliant."
The first concept is a bilateral repo (I'aadat Al-Shira'a or 'IS'). It is the closest to a conventional repo. Two parties agree to a sale by one party in the spot market with a repurchase of an identical (although not necessarily the original) security at a later date at a set price. The set price (not dependent on the market price at the time of repurchase raised issues of riba with the Shari'ah considerations with the scholars they asked. The use of an identical (part of the same offering) rather than the original security was generally accepted as avoiding the problem of debt trading (bai' al-inah).
The second concept changed the purchase undertaking to a wa'd (unilateral undertaking to purchase or sell), but raised more Shari'ah issues that the authors said would be "difficult to overcome". As a result of the difficulties associated with bilateral repos ('IS'), the third concept abandoned the bilateral structure for a three-party structure, which is different from the conventional tri-party repo.
The three-party structure inserted a third party in between the two parties with a sale to the third party by the 'borrower' and a purchase from the third party by the 'lender'. There was also a purchase undertaking for a specified price between the 'borrower' and the 'lender' to return the securities for a pre-specified sale price at maturity of the repo agreement.
The issues in the three-party repo were covered more extensively than in bilateral repo, which suggests that the three-party repo is a more preferable model, at least from the perspective of the report's authors. There remain significant financial and accounting issues concerning margin calls, overcollateralization, accounting treatment of the repos. From a Shari'ah perspective, there are issues with the purchase undertaking, specifically whether it can be exercised by the lender (to force repurchase by the borrower) or whether it is a unilateral promise (wa'd) by the borrower to the lender.
In my opinion, the issues highlighted by the authors are valid and it will be difficult to create a three-party repo that has the substance of a repo transaction (and be acceptable to both parties, regulators and accounting bodies) while avoiding the pitfalls mentioned from the Shari'ah perspective. The sale and purchase transaction at the outset is in the spot markets and is probably acceptable (although if the transaction were overcollateralized, there might be issues). However, the purchase undertaking for securities raises issues that are much more difficult. If the purchase undertaking were unilateral (not binding on the borrower), then it would in essence be a call option, which would not be acceptable for the lender. If the values of the securities fell, the borrower would just abandon them to the lender (let the call expire) and the lender would be left with a loss. In the conventional setting, most repos are conducted using highly secure and highly liquid bonds (like US Treasuries) and the use of overcollateralization or haircuts can mitigate this risk to the lender (as can the enforceability of the repurchase agreement). However, these are not possible in the Islamic repo transaction.
The final concept outlined is one that is essentially a modified commodity murabaha transaction. As in a commodity murabaha transaction, the lender buys a commodity and sells it with deferred repayment to the borrower. Unlike a straight commodity murabaha, the repayment obligation is secured by the sukuk held by the borrower (and overcollateralized to cover fluctuations in the value of the collateral). If the repayment is made on schedule, the sukuk are not sold and is returned to the borrower. If there is a default, the lender takes possession of the sukuk and can sell them to recoup the unpaid repayment. There are a number of issues that were encountered in the three-party repo (margin maintenance, accounting treatment and Shari'ah issues) as well other issues as whether the securities held as collateral could be re-hypothecated (i.e. used by the bank holding the collateral in its own business).
The final concept uses the most similar structure to Islamic short-term liquidity management instruments used today, but if re-hypothecation were allowed, it would be the most 'replicated' product structure. The addition of transfer of securities as collateral (without compensation) on top of the use of commodity murabaha would raise the most objections, I believe, on grounds that the product is cynical and does nothing to really help the industry develop new products. With the three-party repo at least, there would be a purchase and sale of the securities and the obligation created by the wa'd (purchase undertaking) would be based on another purchase of securities, however difficult the Shari'ah and financial issues it presents are.
None of the four proposed methods are perfect and as I described in my newsletter, that was likely from the outset. However, by providing an overview that describes the benefits and the limitations and Shari'ah-compliance issues involved with each, I think that the authors of the IIFM report have done a great service. Not only were the issues laid out, they were done so publicly. While it may receive criticism as being an exercise in replication of a conventional product for the Islamic financial industry, this degree of transparency can only serve to start debate about what alternative structures could be used. For example, would it be more worthwhile for other central banks to follow the lead of the Central Bank of Bahrain and begin issuing short-term (non-tradable) securities like the sukuk al-salam? Is the Malaysian example instructive (it is probably a non-starter on Shari'ah grounds in the GCC)? However, now that four suggestions have been laid out, the burden is on the critics to propose a solution that addresses the need by the Islamic banking industry, moves away from commodity murabaha and wakala and offers a better solution than has been proposed. With the level of talent working in Islamic finance and a shared desire to create a better liquidity management tool for the Islamic financial industry, I believe this is just the first step on the road to a solution to the problem at hand.
Monday, August 02, 2010
Islamic Bank of Britain raises GBP20 million; sukuk markets send mixed signals
There are a number of articles on the Islamic Bank of Britain's raise of GBP20 million at 1 pence per share. The most detailed is from Ovum. There are a couple other articles. Mushtak Parker wonders whether the capital raise "addresses the bank's fundamental shortcomings". At the end of 2009, the bank had 546 million shares issued and outstanding so the 2 billion shares issued in the offering represent significant dilution for existing shareholders and will require approval of the bank's existing shareholders. From a cursory look at the annual report, the increase in the loss in 2009 compared with 2008 was due to a sharp decline in the profits on the bank's assets, despite an increase in the bank's deposits. As the company describes it: "In addition, those customer deposits that have not been used to fund asset growth produced lower returns due to declining yields in the Islamic inter-bank markets affecting the Company's margin."
In short, the balance sheet expanded with the deposit base increasing although those extra deposits were largely placed with other banks in commodity murabaha and wakala agreements (many of whom are based outside of the UK). This is the wrong direction for a bank, particularly an Islamic bank that is supposed to be focused primarily on pure intermediation: mobilizing profit-sharing deposits to finance businesses. Instead, the bank has been able to attract the deposits but has not found enough demand for those funds (or was constrained by capital requirements that would have required more capital based on their risk weighting on the asset side of the balance sheet). There was growth in home purchase plans (Islamic mortgages) from GBP7 million to 33 million, which does provide one good sign for the bank, but as described below, the reliance on Islamic inter-bank markets as a destination for the bank's assets remains high.
If the bank is focused on attracting deposits (GBP186 million in 2009 compared with 153 million in 2008) that it cannot use in a way that attracts a higher rate of return, it is not working the way it needs to be a profitable institution. As the deposits grew, the commodity murabaha and wakala with other banks increased from GBP152 million to 156 million out of total assets that were GBP207 million in 2009 compared to 181 million in 2008. This is a retail bank where around three-quarters of the assets are lent to other banks. I agree with Mushtak Parker; this is a temporary solution to the bank's needs to offset losses and it remains to be seen whether the bank can address its limited ability to find credit-worthy borrowers to finance. [NOTE: As described in the disclaimer on this blog, nothing contained here should be considered investment advice or an offer to buy or sell any security mentioned]
Sukuk yield premiums in the GCC are widening as conventional yields are falling. Another article points to the best month for sukuk since March with yields on some sukuk falling. The discrepancy is probably due to the selection of sukuk; the latter article primarily focusing on Asian sukuk like the Malaysian sovereign and Petronas sukuk. The planned $1 billion sukuk that was reported to be part of a joint venture financing between Saudi Aramco and Total has been abandoned because of market conditions. A Bloomberg article has another take on the Saudi sukuk market, pointing to the likelihood that issuance of sukuk from the kingdom will double in 2010 compared to 2009 and lead the GCC region. Taking these four articles together suggests that investors remain hesitant to invest in GCC-based sukuk after the Dubai debt crisis despite significantly different economic conditions across the countries of the GCC. At the same time, Malaysian sukuk remain attractive to investors.
Other News
In short, the balance sheet expanded with the deposit base increasing although those extra deposits were largely placed with other banks in commodity murabaha and wakala agreements (many of whom are based outside of the UK). This is the wrong direction for a bank, particularly an Islamic bank that is supposed to be focused primarily on pure intermediation: mobilizing profit-sharing deposits to finance businesses. Instead, the bank has been able to attract the deposits but has not found enough demand for those funds (or was constrained by capital requirements that would have required more capital based on their risk weighting on the asset side of the balance sheet). There was growth in home purchase plans (Islamic mortgages) from GBP7 million to 33 million, which does provide one good sign for the bank, but as described below, the reliance on Islamic inter-bank markets as a destination for the bank's assets remains high.
If the bank is focused on attracting deposits (GBP186 million in 2009 compared with 153 million in 2008) that it cannot use in a way that attracts a higher rate of return, it is not working the way it needs to be a profitable institution. As the deposits grew, the commodity murabaha and wakala with other banks increased from GBP152 million to 156 million out of total assets that were GBP207 million in 2009 compared to 181 million in 2008. This is a retail bank where around three-quarters of the assets are lent to other banks. I agree with Mushtak Parker; this is a temporary solution to the bank's needs to offset losses and it remains to be seen whether the bank can address its limited ability to find credit-worthy borrowers to finance. [NOTE: As described in the disclaimer on this blog, nothing contained here should be considered investment advice or an offer to buy or sell any security mentioned]
Sukuk yield premiums in the GCC are widening as conventional yields are falling. Another article points to the best month for sukuk since March with yields on some sukuk falling. The discrepancy is probably due to the selection of sukuk; the latter article primarily focusing on Asian sukuk like the Malaysian sovereign and Petronas sukuk. The planned $1 billion sukuk that was reported to be part of a joint venture financing between Saudi Aramco and Total has been abandoned because of market conditions. A Bloomberg article has another take on the Saudi sukuk market, pointing to the likelihood that issuance of sukuk from the kingdom will double in 2010 compared to 2009 and lead the GCC region. Taking these four articles together suggests that investors remain hesitant to invest in GCC-based sukuk after the Dubai debt crisis despite significantly different economic conditions across the countries of the GCC. At the same time, Malaysian sukuk remain attractive to investors.
Other News
- AAOIFI released two new accounting standards. One which covers sukuk, shares and similar instruments breaks down the accounting treatment based on whether it more closely resembles debt or equity. The other standard provides institutions adopting AAOIFI standards for the first time with a starting point.
- Sameer Abdi of Ernst & Young was on CNBC talking about the E&Y report on Islamic fund management. I posted a few links when the report was released in May.
- Arab News provides a short article on the IIFM report on a potential Islamic repurchase agreements (repos).
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