Islamic Banking and Finance Articles: Sukuk

GLOBALISLAMICFINANCEMAGAZINE.COM--Beyond the talk of proliferating market size, volume of issuances outstanding and innovative new structures and underlying assets, the global Sukuk market is poised to take that great leap forward to a new higher level. Emerging Sukuk models, such as that of the International Islamic Liquidity Management Corporation (IILM), for instance, serve not only to enhance financial stability by facilitating liquidity management for international Islamic financial services, but also to cater for economic development and debt management.

The 2013 London Sukuk Summit, judging by the feedback from speakers and participants, indeed raised the bar of the Sukuk discourse and at the same time managed to engage newcomers to the industry. “It was my first time at such an outstanding event as I have only recently been involved in Islamic Finance,” emphasised Robert Fresco, Director, Legendre Patrimoine.

“I was in charge of launching the first French Sukuk in green energy. The Sukuk Summit was incredible for me and my company, because of the high quality of the speakers and delegates that were present from around the world. Their expertise and insight over the two days of the conference was invaluable. I am now better informed about the Sukuk market and the key players in the industry. The event highlighted how important the Sukuk market is and its importance to the future of Islamic Finance. I hope to be a part of next year's Sukuk Summit and to further establish the business relationships which I had initiated at this year's event,” he added.

The opening session indeed attracted the participation of a premier division of key figures in the global Sukuk architecture. The Lord Mayor of London, Alderman Roger Gifford, in his welcome address, reminded that London as a centre for business and finance has always thrived on openness - openness to the movement of capital and ideas, openness to talented people, and an openness to global business. As such, London’s evolution as a Centre for Islamic Finance, complementing the role of centres in North Africa, the Gulf and Asia, reflects that same global approach.

The Lord Mayor gave the delegates much food for thought when he declared that “in the 21st Century, Islamic Finance is as British as fish and chips and the FA Cup Final. It is an integral part of London’s competitive offer. I look forward to seeing this market thrive and grow in the years to come.”

An international outlook on and clear domestic demand for Islamic Finance - need to be supported by sound regulatory structures, suggested the Lord Mayor. “The Islamic Finance sector is a much valued component in the cluster of services offered by London and the UK, subject to the same regulatory requirements - whether that is in capital adequacy, governance, fairness to clients, the ability and integrity of staff at all levels. This is a strength of London as a centre for Islamic Finance - especially when allied to the strong ethical culture that is at the core and heart of the sector - and should be at the heart of all business,” he added.

Alderman Gifford reminded delegates that the UK’s National Infrastructure Plan provides fantastic opportunities for investors - as the country looks for new capacity and the renewal of the old, across power, water, housing, transport and waste disposal. “All of these offer opportunities which can be met though Sukuk issuance or other Shariah-compliant means, by sovereign wealth funds and other pools of assets in state, corporate or individual hands” he added.

The Baroness Morris of Bolton, the UK Prime Minister David Cameron’s Trade Envoy for Kuwait, Jordan and the Palestinian Territories, representing Baroness Warsi, the Co-Chair of the UK Government Task Force on Islamic Finance and a Senior Minister of State at the Foreign & Commonwealth Office and the Minister for Faith & Communities, conveyed a considered message to the delegates about the “golden opportunity’ presented by Islamic Finance in the UK.

The UK Government in fact also hosted a lunchtime reception for the Sukuk Summit delegates at the historical Lancaster House, where Alan Duncan, Minister of State for International Development and a member of the ministerial team on the UK Islamic Finance Task Force, echoed the historical connections between the contemporary Islamic Finance industry and the City of London and why the Government is committed to working with the industry to further promote London as a premier and preferred hub for Islamic finance. The Co-Chair of the Task Force is Greg Clark, Financial Secretary to the Treasury and the fourth Minister is Lord Green, Minister of Trade.

“It was on a visit to Malaysia and Indonesia,” explained Baroness Warsi, “that I became acutely aware of the power and potential of Islamic finance. Globally the market has grown 50% faster than the traditional banking sector. Britain and British businesses of all sizes can no longer afford to ignore new and emerging markets. We need to demonstrate to the world that the UK is a first class destination for foreign investment and commerce - to show that Britain is open for business. We must constantly be striving for more, and Islamic Finance provides one area where development is possible. It’s not a silver bullet, but it is a golden opportunity. Not least because ten of the world’s 25 rapid growth markets are Muslim majority countries.”

Islamic Finance, continued Baroness Warsi, is not merely for Muslims but for anyone interested in ethical and socially-responsible financial intermediation. The sector is now a global mainstream one which is projected to grow five-fold by the end of this decade. “In the wake of the financial crisis, the principles upon which Islamic finance are based seem more important, more attractive, than ever before. Principles of balance; shared risk; fairness; due diligence; oversight and transparency. Principles that prevent you from selling what you don’t own or attaching a value to assets that do not exist. Islamic Finance could be a sensible, measured banking option, at a time when confidence remains low and the Government is working with the G8 to improve the transparency of financial institutions. This is the right time, right place for Islamic Finance. I am proud to say that the Coalition Government agrees,” she maintained.

She urged the City of London to respond to the challenge and opportunity presented by the global Islamic Finance industry. Given that London is already a major centre for Islamic Finance education, Baroness Warsi, confirmed that the UK Government is looking “at the introduction of accreditation for Islamic Finance education as well as a regulatory body for training providers.”

The UK Government, she added, will support the Islamic Finance industry “in its aim to broaden the range of products and services, reducing the risk of over-exposure and ensuring that high quality Islamic (product) alternatives are available to (British) customers. The Government’s role is to create the regulatory and tax frameworks to allow the market to thrive, and, ultimately, help to produce the growth that Britain needs. By championing Islamic Finance, I believe we are doing just that.”

One way of doing this is the mobilization of Islamic funding and investment for infrastructure projects in the UK. “We are looking at ways the Task Force can mobilise funding, for example in to the top 40 priority infrastructure projects indentified in the National Infrastructure Plan. This is a huge opportunity for the UK, and is a cross-Government effort. The Financial Secretary of Treasury, the Commercial Secretary to the Treasury and I are looking at this in great detail. We will be engaging with private investors, Sovereign Wealth Investors, and major stakeholders including the Islamic Development Bank, in order to realise this vision,” explained Minister Warsi.

The Keynote Speaker, Sheikh Abdullah Saoud Al-Thani, Governor of the Qatar Central Bank (QCB) and current Chairman of the Governing Councils of both the Islamic Financial Services Board (IFSB) and the IILM, laid out a roadmap of the exciting potential and implicit challenges for the global Sukuk market going forward.

In Islamic banking and finance, explained Sheikh Abdullah, the Fractional Reserve banking system does not exist but instead, a 100% reserve banking system exists. “An Islamic bank,” he emphasised, “cannot lend what it does not have, and this you may say, is unfortunate, as this will always cause a disadvantage compared to its conventional competitor, and a level playing field can never exist. This disadvantage though, may become Islamic Finances greatest strength.”

Islamic Finance's essence lies in the concept of risk sharing, which provides a great deal of motivation to develop the Islamic Capital Markets, as these instruments, such as Sukuk, are built on this essence. In most Muslim countries, market share for Islamic banks is well below 20%. “I can only think of the possibilities of what can happen with the Sukuk industry if the momentum of growth for Islamic Finance continues at that 40% compounded rate from 2004 to 2011 that it experienced,” suggested Governor Abdullah.

The mobilisation of investments from Islamic funds especially retail unit trusts into Sukuk issuances that allow for a wider investor base given that the estimated 1,000 such funds lack sophistication, since Islamic equity and fixed income markets do not have sufficient volumes, represents a major opportunity. Savings rates in many Muslim countries too are among the highest rates in the world, which alone presents a large inherent potential for Sukuk and the Islamic Capital Markets, including the promotion of financing and direct investment into Shariah-compliant SMEs.

However, several challenges exist that can limit this potential.

For institutions offering Islamic Financial Services, the limited availability of Shariah-compliant instruments in several jurisdictions continues to pose substantial challenges. The combination of supply and cost considerations has resulted in unnecessarily large holdings of cash by most Islamic Financial Service providers to meet their short-term liquidity needs.

“Addressing the limitations that constrain effective liquidity management practices will be critical not only to support the further development of Islamic Finance, but, more importantly, to promote global financial stability,” stressed Sheikh Abdullah.

Sheikh Abdullah warned that the existing mechanism of Shariah scholars’ involvement in product development, harmonisation and approval may not be adequate for a rapidly growing market that needs to expand according to international standards.

A basic requirement for Shariah compliance of any Sukuk structure is that it shall be backed by real (tangible) assets. Some concern, however, has been raised regarding the limited number of such assets available with Islamic financial institutions. Moreover, according to some reports, the cost of issuing Sukuk can be as much as 60% higher than conventional bonds. These factors could slow down the growth of the Sukuk market.

The strong performance of Sukuk has been largely on the back of sovereign and quasi-sovereign issuances, with corporate issues lagging behind despite the strong growth. Regulation is also a key issue for Sukuk especially creating a level playing field in terms of tax neutrality for both conventional and equivalent Islamic products. The increased use of credit ratings in Sukuk, with the three international credit rating agencies using conventional methodologies to rate Islamic financial instruments including Sukuk despite the fact that Islamic financial institutions and instruments have their own characteristics, also needs to be reconsidered.

Professor Rifaat Abdel Karim, CEO of IILM, in his Special Address, presented a unique vision of the IILM Sukuk Golden Triangle connecting financial stability, economic development and debt management.

The multilateral Corporation was established by central banks, monetary authorities and multilaterals and is mandated to develop and issue short-term Shari’ah-compliant financial instruments to facilitate effective cross-border liquidity management for institutions that offer Islamic financial services. The IILM endeavours to enhance cross-border liquidity flows, international synergies between institutions and more importantly to facilitate financial stability within the Islamic financial systems.

It is no secret that the dearth of Shariah-compliant high-quality, liquid assets (HQLA) is a key risk to which Islamic financial institutions are exposed. According to Professor Rifaat, Sukuk can play a vital role in funding the real economy by ensuring that the funds are used only to finance real assets and that excessive leveraging cannot take place. This contributes to enhancing financial stability. Sukuk can also be tradable and offer a return that can be predictable at a relatively commensurate low risk. As such, they can be Shariah-compliant substitutes for conventional fixed-income securities. As such the IILM short-term Sukuk issuance programme, launched in April, indeed aims at enhancing the ability of Islamic financial institutions to manage their liquidity both nationally and on a cross border basis by creating and issuing Shariah-compliant HQLA.

These instruments, maintained Professor Rifaat, will over time have the characteristics to meet market requirements and recently promulgated international guidelines for liquidity requirements such as Liquidity Coverage Ratio (LCR) Standard adopted by the Basle Committee in January.

The Committee in fact gave national regulators of Islamic financial institutions significant discretions to determine what instruments may be treated as eligible for their liquidity requirements. Not surprisingly, the IILM is focused on obtaining appropriate regulatory treatment for its Sukuk consistent with the requirements of the Basel Committee, and according to Professor Rifaat, “the IILM has started to work closely with its member central banks and relevant regulatory bodies to obtain clear regulatory treatment for the IILM Sukuk and it is likely that this treatment will be favourable for the international Islamic Financial Services industry.

In terms of economic development, the IILM has developed a unique value proposition in supplementing the sovereigns’ current sources of funding (especially raising longer-term funding) that would allow them to finance development projects in their countries.

Multilateral developments banks (MDBs), stressed Professor Rifaat, are a natural partner for the IILM, and can act as credit enhancement providers for their member countries’ obligations to the IILM. This will increase the ability of their member countries to raise funds by selling assets to the IILM on a “temporary separation of ownership” basis. This would provide the member countries with an opportunity to access an alternative source of funding that could be available during market stress periods.

In terms of debt management, the development of the IILM Sukuk market, said Professor Rifaat, will also allow sovereigns to access funding with varying maturities, thereby avoiding funding mismatches. It will also allow for diversification of risks by issuers and investors. As such, the IILM Sukuk may assist sovereigns in their debt management by enabling them to benefit from either sovereign debt re-profiling or from flexibility in funding arrangements.

Another interesting Special Address was that by Dr Nik Ramlah Mahmood, Deputy Chief Executive, Securities Commission Malaysia, who spoke on ‘Facilitating Retail Participation in the Sukuk Market, thus closing the stakeholder spectrum from high finance to ultra retail.

Dr Ramlah, one of the most proactive regulators in the world involved in the Islamic Capital Market (ICM), passionately argued for “the democratization of financial capital” through the broadening of access to the capital market. Sukuk likes bonds, continue to be the domain of the “big boys”, both on the demand and supply sides. Issues like rating requirements, cost of issuance and complexity of documentation meant that capital raising through Sukuk is predominantly by larger corporations and entities. As such, to Dr Ramlah “widening access to the Islamic Capital Market is critical to the development of a successful and inclusive Islamic Finance industry. In supporting this, key stakeholders such as the policymakers, supervisory authorities, Islamic financial institutions and scholars have to explore innovative and inclusive financial solutions that serve the needs of both high finance and high street.”

Indeed, the first Islamic Principles of Commercial Law asserts that wealth (and property) should be circulated among the general public and actively transferred from one hand to another in the form of investment (and expenditure). “It is for this reason that ensuring investment access to the masses has and continues to be a key driver for the development of Islamic markets in Malaysia. It is for this reason too that Malaysia’s Islamic Capital Market has been systematically designed to ensure accessibility and inclusiveness whilst ensuring the protection of investors, efficiency in intermediation, fair and orderly markets and risk mitigation,” she explained.

With a view to facilitating greater direct retail participation in the corporate bonds and Sukuk market, the Securities Commission Malaysia in 2012 developed the framework for retail bonds and Sukuk as envisaged under the Capital Market Masterplan 2. Retail Sukuk is part of the agenda to extend ICM offerings to the masses, enabling retail investors’ access to a wider range of investment products. Under the Exchange Traded Bonds and Sukuk (ETBS) framework, retail investors have direct access to Sukuk thereby broadening the range of low-risk investment products available to them and facilitating diversification for risk management purposes.

Pursuant to the release of the framework, Malaysia’s first retail (exchange-traded) Sukuk was issued by a government-owned entity, Danainfra Nasional Berhad, a company tasked to undertake the development of the country’s first mass rapid transit (MRT) project at a cost of GBP7.9 billion (RM36.6 billion). The retail Sukuk tranche was part of a GBP323 million (RM1.5 billion) government-guaranteed issuance, of which GBP 65 million or 20% was allotted to retail investors and was listed on the Malaysian Stock Exchange (Bursa Malaysia) in February 2013. Proceeds were to be used to part finance the project’s capital expenditure and operating expenses.

“Among the key decisions we had to make prior to the introduction of the framework,” revealed Dr Ramlah, “was to determine whether retail bonds and Sukuk should be offered OTC or on the Exchange platform. The higher cost of trading retail bonds and Sukuk is also a key issue and may also act as dampener to the broader efforts to encourage secondary market liquidity. In this regard, several incentives were introduced in order to ensure that trading fees for exchange traded bonds and Sukuk are competitive. Another area that requires considerable effort is investor education.”

However, she warned against viewing the development of retail Sukuk in isolation because in Malaysia at least it does not do justice to the many other efforts that have and continue to be pursued to extend the reach and relevance of Islamic capital market products and services to a wider spectrum of issuers and investors.

ZAWYA.COM--The passing of Egypt's first sukuk law in May 2013 marks a major milestone in the development of the Islamic finance industry at the national and regional levels. However, the actual value that may result from passing the sukuk law will depend on the adequacy of the regulatory framework in which it will be implemented. The first piece of this important framework is the Executive Regulations of the law, which the government plans to issue in the next few weeks.

The law's drafting and passing were met with several political hurdles. It has been argued by the opposition's figures that the mere fact of passing of such law by a Shura Council, dominated by Islamic parties, particularly the Freedom and Justice Party, is a testament to the Islamic parties' reliance on funding sources from the GCC countries, where Shariah-compliant financial instruments are more popular and developed than they are in Egypt.

Such reliance is seen by part of the opposition as opening the door to political influence from the Gulf. It could be argued that the reason for such unpopularity of Shariah-compliant instruments in Egypt is the suppression of Shariah-compliant finance under the regime of Hosni Mubarak, which contributed in part to the creation of a negative attitude towards Islamic finance.

Some of the critical aspects of the new Egyptian sukuk law are: a) the law's drafting process; b) sukuk issuance under the law and its limits; and c) key provisions regarding Shariah supervision over sukuk issuance and settlement of sukuk disputes.

Drafting the law

The initial draft of the law in March 2013 encountered significant resistance from the Salafist Al-Nour party, which demanded the law be approved by Al Azhar, which is the supreme Islamic authority in Egypt. Al-Nour's objections largely centered on nationalist fears that the law would enable foreigners to own Egyptian public property through issuance of sukuk granting its owners portion of ownership of public assets.

Potentially setting a precedent for review of future legislation by religious entities, President Morsi was forced to refer the law back to Al-Azhar for review. The law was ultimately passed after incorporating Al-Azhar's amendments, and now awaits the issuance of its executive regulation, which is due to be completed in the coming months.

In addition to Al-Azhar's comments, other parties contributed to the drafting of the law, such as representatives and experts of the Islamic finance industry, including the Egyptian Islamic Finance Association (EIFA).

EIFA's efforts and discussions with the Shura Council resulted in the broadening of the scope of law to include both corporate and sovereign sukuk rather than exclusively sovereign. The law allows for both asset-based and asset-backed structures despite EIFA's recommendation to restrict asset-backed sukuk, which has been subject to criticism by various Shariah boards and organizations.

In addition, asset-backed sukuk structures could provide a different cost of financing to issuing parties, as the profit rate would be based on the underlying credit quality as well as the expected performance of the sukuk assets.

Geographic scope

Although sukuk issuance can occur within Egypt and internationally through offshore special purpose vehicles (SPVs), the law stipulates that sukuk assets be located within Egypt, which is likely to limit the size and liquidity of the country's sukuk.

However, given the probable need for financing within the Egyptian market, these limits are not likely to be a problem within the next decade. Indeed, the law is expressly written to discourage capital outflows from Egypt and encourage capital inflows.

Shariah supervision and dispute settlement

A central Shariah board established at the cabinet level shall oversee compliance. Corporate issuers will have their own Shariah boards, but the transaction will also be subject to the central Shariah board's approval. The prime minister will appoint the board's members based on nominations from the finance ministry. To be considered for the central board membership, a candidate must have a Ph.D. in in Shariah and to have participated in at least three sukuk issues.

Although the Egyptian Economic Courts have a general jurisdiction over all sukuk disputes, the law allows the transaction parties to agree on arbitration as a dispute resolution mechanism. The law also leaves the door open to interpretations allowing settlement by foreign arbitration tribunals for offshore sukuk.

Conclusion

The new sukuk law constitutes a bold step towards the development of a Shariah-compliant finance industry in Egypt, and may prove to be a viable resource that could be used to address the current gap in the public funding needs.

Dr. Walid Hegazy has more than 15 years of legal experience with a focus on Islamic banking and finance, project financing, corporate restructuring and corporate governance. Before launching Hegazy & Associates, Dr. Hegazy was heading the Islamic Finance Practice Group at the international law firm of Freshfields Bruckhaus Deringer.

The First International Conference on Islamic Wealth Management

Islamic Finance Glossary

Hasil Survey Lembaga Internasional: Muslim Dunia Inginkan Syariah

Abbreviation and Acronym

Apa itu Keuangan Syariah?

Wednesday, July 2, 2014

Airbus $100 Million Shariah Bet Signals Gulf Carrier Boom

Friday, July 5, 2013

‘Islamic Finance is as British as Fish and Chips and the FA Cup Final’ says Lord Mayor of London

Wednesday, June 26, 2013

Egypt's First Sukuk Law: A Legal Overview

Search This Blog

Pageviews

About Me

Twitter

Labels

Blog Archive