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Everyday I try to make it through as much of the Financial Times as I can, and have yet to feel worse off for my efforts. Some frontier-related musings from Monday:
- Per John Dizard, “it’s worth keeping an eye on the continued willingness of the Baltic states to maintain their [Euro] pegs at such a high cost,” especially since “any subsequent revival in their economies as they regained competitiveness would serve as an ominous example for holders of, say, euro- denominated Spanish assets.” Latvia remains the most likely to de-peg, Dizard writes.
- In light of Prime Rate Capital’s announcement that it will launch Europe’s second sharia-compliant money market fund, Sophia Grene pens an informative overview on the “gap” in Islamic Finance and the role that sharia committees or “scholars” play in authorizing and supporting new products. For instance, the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (Aaoifi)–whose board carries “great weight” in the Islamic investment community–was reported as saying a few years ago that 80% of then-current sukuk structures were not Islamic. “Largely as a result of the uncertainty surrounding sukuk’s sharia status, issuance in 2008 was less than a third that of a year before,” Grene notes, and 2009 issuance levels look to be far short of their 2007 peak. Another reason, however, has been issuer default and the lack of established methods of restructuring the debt. Moreover, the lack of a liquid secondary sukuk market has thus far hampered asset managers who wish to buy and price assets. Yet what market there is (caused in part by sellers not keen on the concept’s relative infancy) has been well-received by new sukuk funds such as those run by HSBC Amanah, the global Islamic financial services division of the HSBC Group.
A Dow Jones report published last week quoted Standard & Poor’s Financial Services as theorizing that the $700 billion global Islamic finance industry would “weather the financial crisis” and moreover would resume its growth on the support of “high demand for Shariah-compliant products, which are considered less risky than conventional debt.” While the global issuance of sukuk fell 35% to $5.3 billion in Q2 compared with last year, a 164% surge in volume in this year’s second quarter compared to the first signaled renewed and robust interest, according to analysts. In fact, Standard Chartered Bank’s CEO of Islamic banking predicts a primary market of “close to $10 billion” by year’s end. The biggest sukuk issuers YTD have been Malaysia and Indonesia, followed by Bahrain and Saudi Arabia, the largest Middle East economy.
Facilitating sukuk’s global growth will be certain legal changes (i.e., tax system overhauls) currently under advisement in countries such as France, Hong Kong, Kenya and Nigeria to assist the introduction of Islamic financial products, which includes not only sukuk but also Murabaha (cost-plus-financing), which is used primarily in commodity finance. According to French authorities, such “tax neutrality” laws will put Islamic products on equal footing with similar, more conventional products, and thus promote equitable tax treatment while boosting their commercial viability.
For example, under new law, a financier’s taxable profit from the deferment of payment granted to the purchaser under Murabaha would be spread evenly throughout the period during which payment is deferred. And in the case where said financier does not reside in France, but his customer is a French national, the profit in question would be exempt from the French withholding tax. And K.C. Chan, secretary for financial services and the Treasury, Hong Kong government, noted earlier this year that changes would be made such that Islamic-derived profits would be made exempt. Hitherto, Hong Kong didn’t impose tax on interest payments, but taxed profits earned, putting Islamic bonds at a disadvantage. Chan added that Hong Kong sees itself as a “gateway for Islamic finance to opportunities in mainland China and other countries in the region including Taiwan, Korea, Vietnam, Laos and Kampuchea.”
An interesting feature in this week’s Economist (“Face Value: Godly but ambitious”) focuses on Adnan Yousif (pictured right), who in 1980 with the Bahrain-based Arab Banking Corporation was one of the first to establish an Islamic-finance practice and is now the chairman of the Union of Arab Banks and chief executive of Al Baraka Banking Group. At the time, a glut of petrodollars in the Gulf was largely invested in bonds [namely American] whose yield was verboten under sharia. Twenty years later, “there were more than 200 Islamic banks and Mr. Yousif was leading from the front.” That said, what the industry lacked, and still lacks today, Yousif argues, is a veritable, global Islamic bank. “Today $700 billion of global assets are said to comply with sharia law. Even so, traditional finance houses rather than Islamic institutions continue to handle most Gulf oil money and other Muslim wealth.”
To fill the gap Yousif wants to create “Istikhlaf” (“doing God’s work”), a sharia-compliant investment bank which will be listed on the Bahrain Stock Exchange and NASDAQ Dubai via an impending, $3.5 billion fourth-quarter IPO, following a $6.5 billion private placement that will comprise its capital base. Per analysts, such larger Islamic banks will be crucial for the industry to realize its growth potential and to compete with Islamic windows or subsidiaries of Western conventional banks that have large market shares in wholesale banking services (Deutsche Bank, HSBC and Citigroup dominate the field presently).
The piece also touches on the practical concerns surrounding the fundamental viability of the concept of Islamic banking itself. Namely: “the rules for Islamic finance are not uniform around the world. A Kuwaiti Muslim cannot buy a Malaysian sukuk (sharia-compliant bond) because of differing definitions of what constitutes usury. Indeed, a respected Islamic jurist recently denounced most sukuk as godless. Nor are banking licences granted easily in most Muslim countries. That is why big Islamic banks are so weak. Often they are little more than loose collections of subsidiaries. They also lack home-grown talent: most senior staff are poached from multinationals.”
Nice aside in FT’s Lex Column yesterday regarding its reservations towards sukuk—Islamic bonds:
Islamic finance is beset by uncertainties. One is how the claims of sukuk holders stack up against those of other stakeholders in the event of default. Last week’s default on a $100m sukuk bond by Investment Dar, a Kuwaiti investment company that owns half of Aston Martin, the UK sports car maker, will be a test case. Courts in general must decide if sukuk – whose returns are based on an ownership claim on assets rather than cash flows – should be lumped in with bonds or be treated more like equity.
Islamic scholars, meanwhile, must agree standards for sharia compliance. Uncertainty on both fronts partly explains why the spread on HSBC’s leading sukuk index remains at four times pre-crisis levels, compared with three times for its conventional Gulf counterpart. Until a more mature regulatory and legal environment emerges, investors who do not face religious restrictions would be wise to stay on the sidelines.
JGW
Frontier Markets 