Fed, BOJ Signal We Are All Islamic Bankers Now: William Pesek

Bloomberg :Attending Islamic finance conferences these days, it’s hard not to notice how this investment class is catching on.

The world’s roughly 1.5 billion Muslims need a way to bank and invest according to Islamic Sharia law, which bars receiving or paying interest on loans or deposits. A massive market infrastructure is being built to facilitate clients that include wildly rich Persian Gulf oil tycoons.

Yet isn’t this industry being pirated by the Bank of Japan, Federal Reserve and other central banks destined to offer interest-free loans? As U.S. President Richard Nixon, echoing Milton Friedman, famously quipped in 1971: “We are all Keynesians now.” By 2009, we may all be Islamic bankers, too.

It’s an odd yet apt comparison. Islamic banking is more about the means by which a certain group of people obtains money. Zero interest rates are about getting as much money, in any way possible, to everyone.

There’s still something to be said about the spreading appeal of scrapping interest rates. It’s no longer a unique aspect of certain transactions or a banking novelty. It’s becoming the norm, and it’s quite disorienting.

Japan’s benchmark interest rate is 0.3 percent and headed to zero in the months ahead. The U.S. federal funds rate is 1 percent and headed lower, too. The U.K.’s rate is 2 percent, Canada’s is 2.25 percent and the euro zone’s is 2.5 percent. As the fallout from the global crisis worsens, these and many other benchmark rates will edge toward zero.

Quantitative Easing

According to Islamic law, the charging of interest, or “riba” in Arabic, is unjust and exploitative. That concept bears little resemblance to Japan’s zero-interest-rate policies, or ZIRP. The BOJ never argued it was seeking to foster brotherhood or socio-economic justice.

But that’s exactly what the BOJ did. By eliminating borrowing costs, and going further in recent years with “quantitative easing,” the BOJ was doing its bit for social fairness and stability. It was about protecting the Japanese way of doing business and maintaining the equalitarianism on which the nation’s 127 million people pride themselves.

Now the Fed is heading down a similar road for similar reasons. With an unprecedented array of emergency-loan programs aimed at easing the worst credit crisis in seven decades, the Fed is engaging in Japan-like quantitative easing. The level of rates is one thing. The more fascinating development is the Fed pushing waves of extra liquidity into the financial system.

Bernanke-san

It’s no wonder that economists such as Michael Feroli at JPMorgan Chase & Co. in New York are referring to Fed Chairman Ben Bernanke as “Bernanke-san” these days.

Some worry the costs of all this will outweigh the benefits.

“The concern is ZIRP encourages inefficiency, and an inefficient allocation of resources is likely to ensue, as occurred in Japan,” says Benjamin Pedley, Hong Kong-based managing director of LGT Investment Management Ltd.

Pedley thinks it’s more important to pursue the kind of fiscal pump-priming counseled by John Maynard Keynes. It’s also vital that central banks buy their domestic bonds, rather than rely solely on interest rates.

“I don’t think zero percent makes a lot of difference to the real economy rather than, say, 1 percent or 2 percent,” Pedley says. “Better to halt rates near zero and rely on other policy avenues to get things back on track and then normalize rates as soon as possible.”

Great Potential

The BOJ never became sufficiently independent to move rates away from zero. The best it did was raise them to 0.5 percent. Politicians got used to easy money. In that sense, 3 percent growth in Japan isn’t as genuine as it is elsewhere. It’s the product of unhealthy and unsustainably easy monetary and fiscal policies. The Fed needs to avoid those pitfalls.

The point here isn’t to downplay a fast-rising asset class. Globally, Islamic banking assets are estimated at $600 billion to $650 billion and have registered annual growth of 10 percent to 15 percent over the last decade, according to Celent, a Boston- based financial research and consulting firm.

That kind of growth means Islamic assets will top $1 trillion by 2010, Alexa Lam, deputy chief executive officer of the Hong Kong Securities and Futures Commission, said at a EuroMoney conference in Hong Kong last month.

The reason why data from Boston and perspectives from Hong Kong are being highlighted here is to show just how anxious the world is to get a piece of Islamic finance. The figures and growth rates speak for themselves. Islamic bankers are looking to marry that potential with China’s rapid growth.

“The pie is getting bigger and bigger,” says Badlisyah Abdul Ghani, chief executive officer at CIMB Islamic, the Islamic banking arm of Malaysia’s second-largest bank.

Only now, the pie is going to get really, really big as the world’s major central banks offer zero-percent loans.

(William Pesek is a Bloomberg News columnist. The opinions expressed are his own.)

Is Islamic finance at tipping point?

Economist:Shari'a-compliant banking is fast moving from niche to mainstream, says Christopher Watts. But while continuing growth seems certain, challenges remain.

In January this year when the UAE's Sharjah Electricity and Water Authority (SEWA) needed cash to construct a power generation and desalination plant in the town of Hamriyah, it was Islamic finance that provided the answer: The utility raised USD 350 m by issuing its first ever sukuk – asset-backed bonds that comply with Shari'a, the Islamic legal code that prohibits interest.

By no means is SEWA alone in venturing into the Islamic capital markets. Corporate sukuk issuance leapt from USD 0.4 billion in 2000 to USD 24.5 billion in 2006, according to International Islamic Financial Market (IIFM), an industry association. Growth topped 122% in 2006 alone. "Islamic finance is no longer a niche market," says David Pace, CFO of Bahrain-based Unicorn Investment Bank (UIB), a Shari'a-compliant house. "It is increasingly a mainstream component of the global banking system."

To be sure, while the world's first Islamic bank was founded back in 1975, it is only in the last five years or so that Islamic finance has surged. Sniffing opportunity, conventional banks are now scrambling to set up Shari'a-compliant operations; and there has been a flurry of all-Islamic start-ups, from full-service investment banks to specialist advisory firms. Products have moved beyond lending, insurance and investment funds to include sukuk, hedge funds, currency swaps, and more.

Despite this boom – largely concentrated in the Middle East and South-East Asia – it's plain the Islamic finance industry still lacks global scale. Professor Rodney Wilson of the Institute for Middle Eastern and Islamic studies at Durham University in the UK estimates Islamic banking assets speak for less than 0.5% of the world's total. And worldwide sukuk debt outstanding amounts to perhaps USD 100 billion – just 0.1% of the global bond market.

Still, the signs point to a continuing surge in Islamic finance. Take economic growth: The Middle East and Asia are the two fastest-growing areas of the world. Kuwait Finance House expects 2007 GDP to rise 6.1% in the GCC and 6.2% in South-East Asia – in contrast to 2.4% in the EU and 2.2% in the US. Oil revenues lie behind the boom in the GCC; and in South-East Asia it is "the financial rigour adopted in the wake of the Asian currency crises," according to Douglas Clark Johnson, CEO of Calyx Financial, an alternative investment adviser based in New York.

Continuing growth in the GCC states and South-East Asia is fast creating a prosperous middle class among the regions' combined 410 m-strong Muslim population. As the ranks of the regions' newly well-off snap up credit to buy homes and cars, and invest in savings and retirement plans, demand for Shari'a-compliant retail financial services is set to accelerate. Behind such consumer products is a need for Islamic institutional finance too.

Consider, too, the vast cash-flows into the GCC region and South-East Asia: The IMF expects Indonesia and Malaysia alone to record a cumulative current account surplus of USD 132 billion for the five-year period to end-2008, in contrast to a deficit of USD 32 billion for the same period a decade earlier. And in the GCC, the surplus should reach USD 680 billion, versus a prior deficit of USD 8 billion.

Buoyed by this cash, regional governments are planning ambitious infrastructure programmes: Indonesia alone expects USD 110 billion of expenditure in the five years to end-2010; and consulting firm McKinsey estimates the GCC will invest USD 200 billion in the same period. Much of this spending is already being financed by sukuk – and the volume is set to balloon: Following its successful sukuk issue, SEWA hopes to raise another USD 2.7 billion. And in neighbouring Dubai, the electricity and water authority is eyeing a debut sukuk issue, with plans to raise USD 2.5 billion.

With ever-stronger foundations in the Middle East and Asia, Islamic finance is now starting to take hold in London, too. The UK's first standalone Shari'a-compliant bank opened its doors in 2004; two others have followed; another is on the way. (All are backed by Middle Eastern institutions.) And in April this year the London Stock Exchange listed its maiden sukuk, adding much-needed depth and liquidity to the market. Another milestone is in sight: the UK government is mulling its first sovereign sukuk issue, perhaps as soon as early-2008.

But challenges remain. If Islamic finance is to move deeper into mainstream global finance, the industry needs to improve transparency and foster credibility by harmonising standards and practices. Not least, Shari'a interpretation varies between regions and even institutions. Regulatory oversight need to be sharpened as well. These measures – and others – could be critical in broadening the appeal of Islamic finance and bridging the gap between Islamic and conventional financial systems.

The Islamic finance industry needs to work on innovation, too. Shari's-compliant products can be more complex than conventional ones because every transaction is backed a non-financial trade. Many instruments are still lacking, including corporate treasury and derivatives products. As UIB's Pace points out: "We [in the industry] need to change our perception of R&D, and view it as a core ingredient of success." But at the same time, innovation is hampered by the limited number of Islamic scholars able to vet financial products for Shari'a compliance.

For certain, industry practitioners are making progress. Earlier this year the International Capital Market Association and the IIFM agreed to develop standard contracts and common best practice for secondary trading of sukuk and other Islamic instruments. And it may help, too, that global banking giants are putting their weight behind Islamic finance. (Deutsche Bank, Barclays Capital and BNP Paribas are already among the world's top five issuers of sukuk.)

The question whether Islamic finance has reached critical mass remains open, of course. But Johnson of Calyx Financial is optimistic: "The tipping point may already have arrived," he ventures. Even if Johnson is wrong in his optimism, it seems unlikely history will prove him to have been very far wide of the mark.

Malaysia courts may get expert help on sharia finance

Reuters - Malaysian courts may need to refer to the central bank's sharia advisers when deciding Islamic finance matters to ensure cases are handled by sharia experts, a newspaper reported on Wednesday.

Islamic banking matters are heard by Malaysian civil courts which are staffed by judges who are not formally trained in the sharia. This has led to criticism that some sharia finance cases may not be decided according to Islamic principles.

'It is learnt that the central bank is reviewing the necessary laws to make this possible,' The Malaysian Reserve said, without citing the source of its information.

There was no immediate comment from the central bank.

The central bank has a board of sharia advisers which gives directions on Islamic finance matters regulated by the central bank such as banking and insurance.

The board consists of sharia scholars, jurists and industry practitioners.

Sharia-compliant finance bans the receipt of interest and investments in companies dealing in alcohol, gambling and pornography.

Islamic finance could play a key role amidst global fears

APP)Key investors and industry figures at their meeting at the second Islamic Finance and Trade Conference considered the best ways forward for Islamic and ethnical finance in the face of the global recession.

At the two-day conference which ended here on Wednesday, British financiers discussed the opportunities Islamic and ethical finance presents in coping with the global financial crisis. Despite the global economic crisis leading financial experts believed that finance governed by Sharia law provides the basis for new income streams that are more stable and offer long-term prospects.

The speakers noted that the City of London has always been at the forefront of many of the developments in Shariah-compliant financial products.

With a global recession imminent, exploring ways of building and strengthening these partnerships and applying the underlying principals of Islamic finance could help contribute to a more stable economy.

A sentiment supported and encouraged by the UK Treasury who hope to encourage further foreign investment as well as creating more British-Islamic institutions in the UK.

In his keynote address, the British Financial Secretary Stephen Timms, said: “There are five dedicated Islamic banks in the UK, one Islamic insurance provider, we see these as great examples, like the MCB (Muslim Council of Britain) itself of something we would like to see a lot more of in the UK, distinctive institutions which are both Muslim and British.

Both at the same time without a hint of a conflict because in that way we will see more and more Muslims contributing to British life and to our aims of a strong economy and society for the benefit of every single person in the UK.”

He went on to explain how the new generation of young British Muslims will be key players in Britainbs future success.

“We want this to be a collaborative effort for everybody involved, with the skills, expertise, and dedication that characterise this industry. I am very optimistic that working together we can ensure that Islamic Finance and Trade are very major elements in London’s success in the decades ahead.”

Timms further said the UK treasury has been working to create the right conditions for Islamic finance to thrive and to benefit both institutions and Muslims living in the UK. He observed that in the current economic climate there is much that can be learnt from finance governed by Shariah law.

Timely Offer Of Stability From Islamic Finance

Bernama -- In creating the awareness and benefits of Islamic financial system, Malaysia is offering itself as the perfect gateway for Middle Eastern financial players to tap in to the Asean region's potential of 600 million population.

Bank Negara Malaysia deputy governor, Datuk Mohd Razif Abdul Kadir today said Islamic finance was no longer a domestic agenda for Malaysia as it was integrating globaly, and that the regulator was even offering various incentives to get the ball rolling for foreign investors and players in the country.

"We have to create awareness of the various opportunities available under the Malaysia International Islamic Financial Centre (MIFC)," he said on the sideline of the MIFC road show to Kuwait and Saudi Arabia, here.

MIFC came into existence in 2006 under a collaborative effort by the country's financial and market regulators including BNM, Securities Commission, Labuan Offshore Financial Services Authority (LOFSA) and Bursa Malaysia - together with industry participation from the banking, takaful and capital market sectors in Malaysia.

"Under MIFC, we can isue new licenses for Islamic banking, takaful and fund managements to conduct international business in Malaysia," he said adding that another incentive for players was a 10-year corporate tax free business.

According to Razif, sukuk or Islamic bonds are now also an important alternative for corporate fundings and Malaysia was a centre for sukuk origination and trading with a record of about 60 percent issuance.

He said despite the globl economic uncertainty since late last year which made it impossible to raise funds via conventional bonds in markets elsewhere, the issuance of sukuk was the opposite with some being oversubscribed.

"The US$4 billion sukuk raised for Maxis buy-out last December was at the peak of the subprime crisis, where it was impossible to tap bond markets elsewhere."

"It was oversubscribed two times, eventhough it was the largest sukuk issuance in the world. This proves that Malaysia's sukuk market is large and very liquid for both local and foreign investors," he said.

Razif said another focus in the Islaimc financial sector was to encourage Middle Eastern players to set up wealth management business in Malaysia to tap high networth investors who want to park their money in Islamic instruments.

"Malaysia has developed a very comprehensive Islamic banking system and robust financial market with various products. The timing cannot be better where the conventional financial instruments have had a depreciation while the Islamic instruments remain steady," he said.

Islamic finance panacea for global crisis: Chapra

ArabNews: The Islamic finance system, which introduces greater discipline into the economy and links credit expansion to the growth of the real economy, is capable of minimizing the severity and frequency of financial crises, says Umer Chapra, a well-known Saudi economist and winner of the King Faisal International Prize for Islamic Studies.
“Islamic finance can also reduce the problem of subprime borrowers by providing them loans at affordable terms. This will save billions of dollars that are spent to bail out the rich bankers,” said Chapra, who at present works as adviser at the Islamic Research and Training Institute of the Islamic Development Bank.

Chapra estimated the derivatives market at $600 trillion, more than 10 times the size of the world economy.

“No wonder George Soros described derivatives as hydrogen bombs while Warren Buffett called them financial weapons of mass destruction,” he pointed out. The derivatives include credit default swaps (CDS) worth $54.6 trillion.

The Islamic economist described the present global financial crisis as the worst in four decades. “There is a lurking fear that this might be only the tip of the iceberg. A lot more may come if the crisis spreads further and leads to a failure of credit card institutions, corporations, and derivatives dealers,” he warned.

Chapra urged Muslims to establish a genuine Islamic finance system with proper checks and controls, adding that such a move would encourage others to embrace it.

The Islamic system does not allow the creation of debt through direct lending and borrowing. It rather requires the creation of debt through the sale or lease of real assets by means of its sales- and lease-based modes of financing such as murabaha, ijara, salam, istisna and sukuk.

Spelling out the regulatory regimes in the Islamic system, Chapra said: “The asset which is being sold or leased must be real, and not imaginary or notional; the seller must own and possess the goods being sold or leased; the transaction must be genuine with the full intention of giving and taking delivery; and the debt cannot be sold and thus the risk associated with it cannot be transferred to someone else.”

He said the conditions set by the Islamic system would help eliminate most of speculative transactions. “Financing extended through the Islamic products can expand only in step with the rise of the real economy and thereby help curb excessive credit expansion,” he said.

Chapra emphasized the significance of the condition that prevents a creditor from transferring the risk to someone else by selling the debt. “This will help eliminate a great deal of speculative and derivative transactions where there is no intention of giving or taking delivery. It will also help prevent an unnecessary explosion in the volume and value of transactions and the debt from rising far above the size of the real economy,” he added.

It will also release a greater volume of financial resources for the real economic sectors and, thereby, help expand employment and self-employment opportunities and the production of need-fulfilling goods and services.

The discipline that Islam wishes to introduce in the financial system may not materialize unless the governments reduce their borrowing from the central bank to a level that is in harmony with the goal of price and financial stability, Chapra said.

“In the Islamic system, credit is primarily for the purchase of real goods and services which the seller owns and possesses and the buyer wishes to take delivery. It also requires the creditor to bear the risk of default by prohibiting the sale of debt, thereby ensuring that he evaluates the risk more carefully,” he explained.

He said excessive and imprudent lending by banks was the main cause of the current global crisis.

“There are three factors that make this possible: inadequate market discipline in the financial system resulting from the absence of profit and loss sharing (PLS); the mind-boggling expansion in the size of derivatives, particularly CDSs; and too big to fail concept of banks who believe that the central bank would come for their rescue.”

The false sense of immunity from losses introduces a fault line in the system as banks do not undertake a careful evaluation of their loan projects. This leads to an unhealthy expansion in the overall volume of credit, to excessive leverage, and to an unsustainable rise in asset prices, living beyond means, and speculative investment. Unwinding later on gives rise to a steep decline in asset prices, and to financial frangibility and debt crisis, particularly if there is overindulgence in short sales.

Chapra said the subprime mortgage crisis in the US was also the result of excessive and imprudent lending. “Securitization or the originate-to-distribute model of financing has played a crucial role in this. Mortgage originators collateralized the debt by mixing prime and subprime debt. By selling the collateralized debt obligations (CDOs), they passed the entire risk of default to the ultimate purchaser. They had, therefore, less incentive to undertake careful underwriting.”

Consequently a number of banks have either failed or have had to be bailed out or nationalized by governments in the US, the UK, Europe and a number of other countries.

“This has created uncertainty in the market and led to a credit crunch, which has made it hard for even healthy banks to find financing,” he said.

“When there is excessive and imprudent lending and lenders are not confident of repayment, there is an excessive urge for resorting to derivatives like CDSs to seek protection against default. The buyer of the swap (creditor) pays a premium to the seller (a hedge fund) for the compensation he will receive in case the debtor defaults,” he added.

Finance with a moral foundation

BBC News:In the midst of turmoil in the global financial system, there is one branch of finance that aims to operate within strict moral and ethical boundaries - Islamic finance.

But how will it survive in the current climate?

Opposite London's largest mosque, in the heart of the capital's Muslim community, is a branch of the Islamic Bank of Britain.

It is one of eight branches around the UK that bring Islamic finance to the high street.

It looks just like any other high street bank – but manager Abu Fozoll tells me that it offers finance with a difference.

“Every single product we offer here is all Sharia compliant. From home purchase plans to direct savings, these are all governed by Sharia principles.”

That means there's no mention of interest – instead, savers are offered a projected share of profits.

In practice, Muslims can still get a return on their investment, but without compromising their religious principles.

High street Islamic finance is just one small part of a thriving industry.

In London's Canary Wharf, I attended a conference of financiers assessing the prospects for Islamic finance.

Talk of the credit crunch was never far away, but some delegates believe the ethical principles that underpin Sharia-based finance mean it will better weather the current financial storm.

Mufti Mohammed Zubair Butt is chairman of the UK's first panel of sharia scholars, who rule on whether particular products or services meet strict Islamic criteria.

He is optimistic about the sector's future: “It has an alternative to present. It has a method to show to the world that things can be done in a different way which is more ethically sound and more financially sound too”.

One expert on Islamic finance, Durham University professor Rodney Wilson, points out that no Islamic financial institution has yet failed in the current crisis.

He contrasts “excessive risk-taking” in the mainstream financial sector with “a fairly classical banking model” still followed by Islamic institutions.

Regulation

But there are challenges facing Islamic finance.

One key concern is the lack of regulatory framework within the sector, meaning that Sharia scholars are free to differ over what constitutes Sharia-compliance.

It can lead to inconsistency when it comes to rulings about what sort of investments are appropriate.

Andy Critchlow, middle east managing editor for Dow Jones, warned that Sharia boards consulted by financial institutions may not always be as independent as they appear.

“Companies appoint their own Sharia compliancy boards. Companies pay those Sharia compliancy boards to actually structure the Sharia compliant agreement for them,” he says.

“The industry in many respects is a house without foundation in that it doesn't have the foundation of regulation underpinning it.”

Of course, the value of regulation is currently hotly contested throughout the financial industry, but proponents of Islamic finance believe that its in-built adherence to Islamic law means it offers a fairer, more ethical financial system.

What no one can predict is the extent to which Islamic finance's principles will mean it is better shielded from the current financial storms.

Some fear that it is already so entwined with mainstream finance that its future is as risky as any other part of the global financial industry.

Asia's Islamic finance sector weathering storm well

Radio Australia:As Wall Street gets to grips with its biggest one-day point drop in history, after US legislators voted down a massive bailout plan, new figures show one global finance sector might be in strong enough shape to weather the storm. Dow Jones has just put out the August results of its Islamic markets financial index. While the Dow's Global Titans 50 lost more than two-and-a-half percent of their value in august, the 100 leading Shariah-compliant stocks suffered only half that loss. During Asia's financial crisis eleven years ago, the region's Islamic stock markets outperformed their conventional counterparts.....Read more...

Islamic banking restrains bankruptcy

RGE Monitor ::The fall of giants in the world financial sector like Lehman Brothers in the aftermath of the US sub-prime mortgage crisis, we need to be strict about credit rating system to restrain chances of any further bankruptcy. Interestingly, since Islamic banking adheres to strict credit rating system and disallows indebted economic agents to avail more debt finance, it could save our financial and economic enterprises from bankruptcy.

Interest is strictly prohibited in Islamic banking and principles of equity finance disallow financing the indebted enterprises, the chances of bankruptcy considerably decline. Under Islamic banking since equity finance need pre-rating analysis of projects after reviewing cost yield analysis, it tends to reject the economically weaker. Islamic banking principles thus reduces the throat cut competition in financial sector to get more credit shares and tends to provide stability in the financial market.

Since principle of Islamic equity finance allows the banks to recover the assets by right of ownerships, it would be fairer on the part of financial institutions to recover assets in case of any bankruptcy or crisis, which may not be found in interest-based lending by SCBs and financial institutions because in later case the lender have no right over assets financed to debtors. Thus to strengthen the stability in financial sector and avoid chances of bankruptcy, the system of Islamic equity finance should be promoted through Islamic banking instead of raising scope for throat cut competition among banks and financial institutions by compromising lending rates to attract more credit shares.

It would be interesting in part of the financial sector reform to evaluate the credit rating system adopted by our conventional credit rating agencies and the practices adopted by Islamic bankers and financial institutions in the international financial market. It would certainly help us improvise our rating system to prevent any bankruptcy in future.

Salmond targets Qatar for cash

Scotsman: ALEX Salmond is to ask a cash-rich Arab state to stump up billions of pounds to pay for desperately-needed upgrades to Scotland's creaking road, rail and power networks.
The First Minister will head to Qatar next year with plans to persuade the oil-rich emirate to act as Scotland's banker. Salmond wants Qatar to loan funds for massive capital projects the Scottish Government cannot afford, including the £4bn new Forth Road Bridge and a £5bn undersea electricity cable.

The plan – dubbed by critics a "Middle Eastern PFI" – would involve the Scottish Government paying back any loans over decades.

Labour last night warned the plan could lead to Scottish assets falling into the hands of foreign owners, who stood to make huge profits out of any investment.

But observers say Salmond has few options: the Scottish Government has too little surplus money in any year for major projects and the SNP has itself ruled out conventional PFI funding.

Governments across the Western world are looking towards the Middle and Far East to secure finance from their sovereign funds, the state-owned investment funds which nations such as Qatar have built up on the back of huge oil profits.

Qatar's fund alone is now believed to be worth $60bn, a figure which is expected to double by 2010. The International Monetary Fund, a global organisation which lends money to struggling nations, says that total investments by sovereign funds will hit $12,000bn by 2012.

Any deal with Scotland would see a foreign sovereign fund paying up-front to build a major project, and then being paid back over a number of years, with interest.

The Scottish Government is understood to have already begun preliminary talks over the plan for a huge under-sea electricity cable in the North Sea, which would allow wind and wave power from the north of Scotland to be transmitted to the south of England.

Bankers are already eyeing up major projects, such as the new Forth Bridge as a possible contender for Middle Eastern investment.

One Edinburgh banker said: "The Scottish Government is looking at sovereign funds, along with everyone else. This is a fact. You follow the money and it goes to the Middle East. They are trying to do just that."

Scotland on Sunday can reveal that Salmond has personally requested that the Islamic Finance Council – a Scottish-based body which represents Islamic financial interests – to explore "the possibility of using Islamic financing structures to address the infrastructure needs of Scotland".

Under this scheme, ministers would issue a special bond which meets Islamic ethical investment standards in return for up-front funding – known as a Sukkuk. The UK Treasury is understood to be about to issue such a bond later this year.

It is required if governments are to fully tap into the vast resources held by the Middle Eastern sovereign funds.

Omar Shaikh, a board member at the IFC, said the moves simply reflected the new world order in the wake of the credit crunch, which has seen loans from banks dry up.

He said: "Where is the money at present? It is in these sovereign funds. You are looking at £5 trillion of wealth. It is a problem for them to find quality assets to invest in."

Of Salmond's visit to Qatar, he added: "This kind of plan is something we have been promoting for some time. Scotland is actually slow in getting off the mark here. Obviously, it is important that Scotland gets the best deal, but it is also important that we deal with those who have the money."

The Qatar visit has been planned for some time and follows similar visits by political leaders in both Wales and Ireland. A spokeswoman for the Scottish Government said: "The Scottish Government is in ongoing discussions with the Qatari government, exploring options for a possible visit by the First Minister intended to establish broader business and investment links."

A source close to the First Minister added last night: "In challenging economic circumstances, it is even more important that the Government pursues every single business and investment opportunity to grow the Scottish economy."

The potential for a deal is nearly limitless, say finance chiefs. A report by the IFC to the Scottish Government, submitted earlier this year, specifically focused on the Forth Road Bridge.

It declared: "Market reports indicates that the Scottish Government is looking for funding of £3bn+ in the coming years, indeed the cost of a new Forth Road Bridge is estimated to be between £3.2bn and £4.2bn. Within the budget constraints that the current Scottish Government has to work within they need to look for more radical funding streams, different funding streams, innovate funding options."

The IFC says the taxpayer could be better off under such an arrangement than under the old PFI scheme, as rates of return would be more attractive.

The task of securing funding for Scotland's major infrastructure projects has now been handed over to the Scottish Futures Trust, headed by Sir Angus Grossart.

However, Labour last night said the plans smacked of hypocrisy. Finance spokesman Andy Kerr said: "For Mr Salmond and his party, who spent the last few months and years telling the people of Scotland that they were against private profit in public services, it is ironic and hypocritical of them to be now chasing sovereign funds in the Middle East."

He added: "However, given the record of recent sell-outs by the SNP, the people of Scotland will be not be surprised. They have spent the last 18 months trying to replace PPP, shattered confidence in the marketplace in Scotland and came up with the Scottish Futures Trust, or as Unison and almost everyone else would call it, PPP Mark Two. Now they know they have a problem funding their commitments they are off to the Middle East to sell Scottish assets to foreign investors."

Sharia finance needs real deal, not copycats - scholar

Reuters - Sharia banking needs to develop more of its own products and avoid imitating conventional financial instruments in structures that compromise the spirit of Islam, a leading religious scholar said.
Sharia instruments have to satisfy Islam's objective of ethical and equitable investing while retaining a commercial proposition that can draw investors who plough in funds with the aim of reaping returns.

Scholars say Islamic bankers sometimes tailor sharia instruments according to market demands to ensure they can be more easily sold as Islamic assets vie for investors that also have access to a wider range of conventional banking products.
"People tend to, to a certain extent, dilute some of the principles or objectives of certain contracts in order to accommodate conventional features," Mohammad Akram Laldin told Reuters in an interview on Thursday.

For example, in the mudaraba partnership contract where the bank provides capital finance for a venture, the parties are required to share the profits but the bank bears any monetary loss. However, this is sometimes tweaked as investors demand capital protection, he said.

Akram cited the diminishing musharaka and takaful, or Islamic insurance, as examples of pure breed Islamic products that are not derived from conventional finance.
The diminishing musharaka is a partnership where a bank gradually reduces its equity in a project and ultimately transfers ownership of the asset to the participants.

TROUBLED SCHOLARS

The $1 trillion Islamic finance industry is growing 10-15 percent a year mainly because of a deluge of Middle East oil money.
But religious scholars are worried that some industry practitioners could be watering down the strict requirements of Islamic law in a quest to broaden the sector's appeal.

The Accounting and Auditing Organisation for Islamic Financial Institutions, or AAOIFI, a body that sets Islamic financial standards across the Middle East, rocked markets last year when it said 85 percent of Islamic bonds did not comply with Islamic law because of repurchase agreements.

Most Islamic bonds have been sold with a repurchase undertaking -- a promise that the borrower will pay back their face value at maturity, or in the event of a default, mirroring the structure of a conventional bond.AAOIFI said this promise contravenes the obligation to share risk in the case of several types of Islamic bonds. The bonds should be bought at market value at maturity.

Akram, a Jordan and UK-trained scholar who has been involved in religious teaching for about 13 years, said the Islamic industry's tendency to copy conventional instruments stemmed from a lack of experts skilled in both the sharia and finance.
"We have this gap in the market, between the sharia practitioners and market practitioners in terms of knowledge as well as exposure," said Akram who sits on various sharia advisory boards including HSBC Amanah.

"The result of this is you can see that there is a lot of conventional products that are being 'Islamised' because most of the product development team are people from conventional (markets) which have conventional practice."Sharia advisers are a small and influential breed, sitting on the Islamic boards of institutions and ruling on whether or not proposed Islamic products meet the sharia's conditions.

Sharia still at heart of Islamic finance

THE ECONOMIST : The modern history of Islamic finance is often dated to the 1970s, with the launch of Islamic banks in Saudi Arabia and the United Arab Emirates. But its roots stretch back 14 centuries.

Islamic finance rests on the application of Islamic law, or sharia, whose primary sources are the Koran and the sayings of the Prophet Muhammad. Sharia emphasizes justice and partnership.

In the world of finance that translates into a ban on speculation (or gharar) and on the charging of interest (riba).

The idea of a lender levying a straight interest charge, regardless of how the underlying assets fare in an uncertain world, offends against these principles — though some Muslims dispute this, arguing that the literature in sharia covering business practices is small and that terms such as "usury" and "speculation" are open to interpretation.

Companies that operate in immoral industries, such as gambling or pornography, are also out of bounds, as are companies that have too much borrowing (typically defined as having debt totalling more than 33 per cent of the firm’s stock market value).

Such criteria mean that sharia-compliant investors steer clear of highly leveraged conventional banks, a wise choice in recent months.

Despite these prohibitions, Islamic financiers are confident that they can create their own versions of the important bits of conventional finance.

The judgment of what is and is not allowed under sharia is made by boards of scholars, many of whom act as a kind of spiritual rating agency, working closely with lawyers and bankers to create instruments and structure transactions that meet the needs of the market without offending the requirements of their faith.

Non-Muslims may find the distinctions between conventional finance and Islamic finance a trifle contrived. An options contract to buy a security at a set price at a date three months hence is frowned upon as speculation.

A contract to buy the same security at the same price, with five per cent of the payment taken upfront and the balance taken in three months upon delivery, is sharia-compliant. Then again, winning over non-Muslims is not really the point.

There is no ultimate authority for sharia compliance. Some worry that this may hold the industry back. Malaysia has tackled this by creating a national sharia board.

Some industry bodies, notably the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) in Bahrain, are working towards common standards.

That a few scholars dominate the boards of the big international institutions also helps create consistency. But differences between national jurisdictions — between pious Saudi Arabia and more liberal Malaysia, say, are likely to remain.

Both of these countries feature in the top three markets for Islamic finance, measured by the quantity of sharia-compliant assets.

Top is Iran, although international sanctions keep its industry isolated.

The Gulf states, awash with liquidity and with a roster of huge infrastructure projects to finance, are the most dynamic markets.

Britain is the most developed Western centre, although France, with a much larger Muslim population, wants to close the gap.

Controversy and Islamic Banking

Asharq Al-Awsat- I read a press report that stated that prominent members in the field of Islamic banking in the Middle East have branded Sheikh Muhammed Taqi Usmani a conspirator against sukuk [Islamic bonds] and that Westerners did him justice in the wake of his comments that 80% of sukuk are non-Shariah compliant.

The truth is that despite following up on the repercussions of the Sheikh’s statements about Islamic bonds in newspapers, I have only found comments of this nature in some Western papers that branded Shariah committee members as having sold their religion in order to push Islamic banking to the fore. As for those who work in the field of Islamic banking, they have only issued warnings about the negative impact that this statement might have on the issuance of sukuk.

In this respect, I was amongst those who warned of these negative repercussions. Moreover, I have criticized the approach that was taken by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) in dealing with the statement because it failed to clarify what was meant by Sheikh Taqi Usmani’s comments. However, not one Muslim can discredit Sheikh Taqi Usmani as a conspirator against sukuk for a number of reasons including the following:

Firstly, the Sheikh was simply carrying out a duty that God made compulsory upon scholars. The Quran states: “And remember Allah took a covenant from the People of the Book, to make it known and clear to mankind, and not to hide it; but they threw it away behind their backs, and purchased with it some miserable gain! And vile was the bargain they made! (Surat Al Imran: Verse 187). The Sheikh’s statement was one of truth, a manifestation of knowledge and a clarification of the rulings of Quran and Sunnah [Prophetic traditions].

Secondly, the Sheikh’s actions were based on propagating virtue and preventing vice, which is an obligation according to Shariah. Abu Said al Khudri (may God be satisfied with him) said that the Prophet Mohammed (PBUH) said: “Whoever of you sees an evil action, let him change it with his hand; if he cannot, then with his tongue; if he cannot, then with his heart - and that is the weakest belief.”

There is no doubt that the method that the Sheikh prohibited is a vice that must be rejected and changed. The statement issued by the AAOIFI agreed with the Sheikh in rejecting these methods and the necessity to correct them. However, we disagree with the Sheikh on the way that this vice has been rejected in that we would have preferred this to have been done through scholarly debate with other sheikhs rather than via press reports. Perhaps the Sheikh believed that this method of his was more intense and would be more beneficial in rectifying the mistake.

Thirdly, the position of the Sheikh at the head of numerous Shariah committees of Islamic financial institutions and services related to this industry, atop of which is the AAOIFIs Shariah council, contradicts the accusation [that he is a conspirator against sukuk] as he is one of its most prominent ideologues and scholars.

Fourthly, the fact that the Sheikh has remained at the top of the Shariah committees of these institutions following his comments indicates that the press report that claims that those in charge of Islamic banking described him as a conspirator is incorrect. If this was the case then he would not remain at the head of these Shariah committees.

What Sheikh Taqi Usmani did clearly indicates that Shariah committee members fear God in everything they do and do not shy away from telling the truth or revealing evil acts. This strengthens the trust in them and in the Islamic financial institutions that they supervise and invalidates the claims of those who hint that these people receive payment for work that other people are doing.

I ask God to reward Sheikh Taqi Usmani for all that he has offered.

Islamic banks warned against cloning models

MANAMA: The Islamic finance industry needs to develop new models and make sure it is in a position to withstand an economic slowdown, the Central Bank of Bahrain (CBB) governor warned yesterday.

Newer entrants to the industry have merely tended to copy the strategies they see being successfully pursued by their more established rivals, Rasheed Al Maraj warned delegates at the Euro World Islamic Banking Conference (Euro WIBC) in London yesterday.

"If I may say so, there is a high degree of cloning of business models," he said.

"As a result, a very high percentage of Islamic banks have a strategy that is heavily weighted towards real estate and asset finance.

"They tend to be project-driven and do not have a steady source of bread and butter revenue to tide them over any downturns in economic activity."

He said that asset-based business models favoured by many Islamic banks have not been tested in a downturn.

"We need to remember that a business model which looks robust in conditions of rising asset values and abundant liquidity may not be so when the economic environment changes," he warned.

"The industry needs to respond to these challenges by developing a greater diversity of business models, more diverse and stable income sources, and more rigorous risk management and stress testing techniques to assess its preparedness to deal with any downturn in economic activity.

"As a central banker, I am inevitably preoccupied by risk, especially when it could potentially impact on a significant sector of the financial industry."

He said the asset base of Islamic finance contrasted with that of conventional banks with their extensive loan books, overdraft and credit card facilities which provide steady revenue to cover their overheads even in today's challenging markets.

"The cloning of business models in Islamic finance leads to financial institutions becoming exposed to the same economic and industrial sectors," he said.

"The Islamic banking sector as a whole is highly exposed to the property sector - real estate, commercial property and construction - and as events in the advanced markets have recently reminded us, this sector can and does experience significant cycles of activity."

He said that in spite of these challenges, the Islamic financial industry continued to offer enormous opportunities for both Muslims and non-Muslims alike.

"We at the CBB have a continuing commitment to facilitating the development of the Islamic financial services industry," he added.

"We will continue to ensure that all financial institutions in Bahrain adhere to the very highest international standards. Where necessary we will play our part in adapting those standards to the needs of the Islamic financial services industry," he said.

Influence of sharia banking growing in Western finance

Globe and Mail (Toronto)--For the consortium led by U.K. racing entrepreneur David Richards to acquire Aston Martin from Ford Motor, the consortium's partners, Investment Dar and Adeem Investment, both of Kuwait, required the deal to be done according to Islamic principles. The $848 million deal highlights the growing influence of Islamic finance in the Western world. A new wave of Islamic banks is looking to the West while Western banks are offering Islamic finance services.

Finding safety in Islamic finance

Gulf News -- Islamic finance continues to gather pace with a recent report estimating that Sharia-compliant assets now exceed $1.7 trillion and are projected to reach $2.7 trillion by 2010.

But that is not without its challenges and debates. Amongst other challenges that have been highlighted, there is continued debate on the need for a central "Sharia Council" to introduce standardisation across the industry. It is important that we balance this need against that for continued product innovation and the ability to introduce new solutions to the market in a timely manner. The industry doesn't need to be constrained but governed.

The growth to date has been focused on the development of institutional and corporate structures, but there is increased discussion on the need to further develop Sharia-compliant investing. To date Sharia-compliant investing has been perceived by many investors as underperforming the conventional investment market. In fact a recent report shows that Islamic investors continue to choose conventional investment solutions over Sharia-compliant structures, indicating that they may be putting their religious beliefs second to investment performance. But recent market volatility has shown contradictory results, and has highlighted the strengths of Sharia investments.

Conventional equity funds have been hit hard by the subprime fiasco and continue to suffer the ongoing effects of the credit crunch. For Sharia-compliant equities, 2007 was a strong year with Islamic indices outperforming their conventional counterparts and are continuing to do so till now in 2008.

Figure 1 highlights the strength of Sharia equity funds from early on in the 2007 subprime crisis. Sharia performance tracked conventional equity markets in the early days, and at the "official start of the crisis" in February 2007, The Dow Jones Islamic Developed World Index began its move away from the declining MSCI World Index and has shown consistent outperformance to date.

Sharia-compliant structures have many screens and requirements that should be recognised as contributing to this outperformance. The oft-quoted aversion to the financial services sector is only one of those. In addition, the Sharia filters resulted in an overweight of cyclical sectors such as information technology, health care and energy and underweight for more defensive stocks such as consumer staples and utilities. These sectoral allocations resulted in further outperformance relative to the industry's conventional counterpart. This trend has been consistent since December 2006.

Figure 2 highlights the common view that the industry and financial ratio filters for Sharia compliance limit the universe of investible stocks, potentially impacting performance in a negative manner. However, Sharia investors appear to have benefited from the characteristic exclusions and the favouring of sectors that have proved resilient in the current economic climate.

Of greater significance has been the due diligence procedures associated with stock/company selections that are mandated under Sharia principles; the exclusion of highly leveraged companies became a key factor through this period.

Strength

Highly leveraged companies suffered over the recent period, and stocks showing lowest level of debts on their balance sheet outperformed by almost 35 per cent (see Figure 3).

Quantitative ratio filters mean that the Sharia-complaint universe is generally made up of companies with strong cash flows, robust returns on equity, and a solid balance sheet.

These characteristics have clearly been rewarded in a period of credit and liquidity constraints, whilst the volatility in stock prices of highly leveraged firms significantly increased through the recent market downturn.

The need for stringent research to ensure compliance, both pre and post the purchase of any stock, is another key benefit of Sharia investing. In considering total debt to market capitalisation off-balance sheet debt has to be considered as well and research has to be extensive. Avoiding excessive stock trading and adopting a buy and hold strategy also tends to fare well for Islamic funds as constant trading can tend to drag down a portfolio's overall performance.

In conclusion, we believe there is a strong argument to support the notion that Sharia investing is not the "poorer cousin" of its conventional counterpart, but is a viable alternative approach.

Whilst the behaviour of Sharia funds at the individual fund level is no different to conventional counterparts in that some will outperform and others will underperform, recently Islamic indices have highlighted that their low-debt, non-financial, socio-ethical approaches work in market downturns. This trend was not unique to the MSCI World vs DJ Islamic, but can be seen across the US, Europe and the Asia Pacific markets.

Islamic finance on the rise

Embryonic. That’s the best way to describe Islamic finance practices of Asian law firms outside of Malaysia, but there’s no doubt that there are high expectations for the growth opportunities on offer. Lawyers specializing in Islamic finance, while traditionally based in Dubai or London, are keeping a close eye on developments in the Asia region.

Oliver Agha, partner and Global Head of Islamic Finance at DLA Piper, has over 50 lawyers worldwide in his Islamic finance practice group. “It’s hard to get firm statistics, but we believe it’s the largest such group in existence,” he says. Clifford Chance, Norton Rose and Linklaters are other examples of firms which have worked on substantial Islamic finance transactions.

Of course, when one talks of team size, this begs the question of how law firms are structuring their Islamic finance teams. “I don’t see it as a distinct practice area,” says Hooman Sabeti-Rahmati, Senior Counsel at Allen & Overy Shook Lin & Bok, “Islamic law is a body of law which ultimately needs to be applied to a structure or product. The knowledge of Shari'a is important, but the starting point must be knowledge of the underlying product. This is because most Shari'a-compliant products today are designed to replicate the economic and risk profile of a conventional counterpart.”

Agha places a heavy emphasis on Shari’a knowledge, hiring lawyers who are also Islamic scholars and adopting a sound understanding of Islamic jurisprudence as a starting point. “A lot of firms are simply trying to replicate conventional structures into a Shari’a compliant structure,” he says, “Our approach is to start with a genuinely compliant structure and to build the product from that.”

Banks and other entities looking to raise capital are increasingly turning to Shari’a compliant offerings. A key reason, says Hooman Sabeti-Rahmati, is the abundant investment capital currently available, and increasingly so, in the Middle East. “Middle Eastern investors generally have not been averse to investing conventionally if Islamic alternatives were unavailable, but now that compliant alternatives are more available and growing, there is ready demand for them, which invites further innovation and growth,” says Sabeti-Rahmati.

Agha agrees and says that Islamic finance is increasingly important as a substitute for conventional financing in light of the credit crunch. “You can see this in the current proliferation of Islamic funds, which is occurring as the traditional market is contracting,” he says.

Jurisdictions

Islamic finance is an area of exponential growth for law firms, says Oliver Agha. “The main growth has been in the Middle East, but there’s also been strong growth in Asian markets. Kuala Lumpur has always the main [Asian] centre for Islamic finance, but in recent years we’ve seen other jurisdictions such as Thailand, Japan and particularly Singapore take an interest.”

Hong Kong, in particular, is keen to establish itself as the gateway for Muslim investment into mainland China – intentions that were made clear by developments such as last year’s opening of the Hang Seng Islamic China Index Fund. “If they’re able to establish Hong Kong as a viable Islamic finance jurisdiction, I can see Hong Kong, along with Kuala Lumpur, being the region’s hot spots for Islamic finance,” says Agha.

Multiplying on the global stage

By Yadullah Ijtehadi

From being the flavour of the month, sukuk have quickly been elevated to become a viable long-term funding instrument for many of the Gulf's corporations.

This meteoric rise from being an alternative proposition to a mainstream reality has not gone unnoticed in the rest of the world, as international financial centres such as London, Tokyo and Hong Kong are altering their laws to accommodate sukuk and Islamic finance.

The German state of Saxony-Anhalt has already issued an AAA-rated five-year sukuk, while China, Japan and Thailand are reportedly planning to issue sovereign sukuk this year.

But for now the momentum is with the Gulf states.

This year alone, firms in the Gulf have raised $6.12 billion (or 61 per cent) in 22 issues of the total sukuk issued to date (June 15). Gulf corporates raised $18.72 billion, or 55 per cent, of all sukuk issued globally last year.

The rise of sukuk is part of a much bigger tide that has swept across the Gulf states. On the back of triple-digit oil prices, GCC sovereigns have now become one of the biggest exporters of capital globally, investing in high-profile blue chip companies, apart from emerging and developed markets.

These Gulf companies are seeking funds from the market to raise capital for their ambitious domestic and global expansion either in the form of public offerings, private placements, syndicated loans and bonds. All these options are in huge demand and sukuk are no exception.

Deustche Bank's outlook projects more prominence for the sukuk market going forward. "In our view, if we assume that only 10 per cent of the region's investment needs will be met by international sukuk issuance this would still imply a doubling of the existing international sukuk stock within two years, reaching close to $100 billion by 2010 ... we are starting to see the tip of the investment iceberg," says the bank in a report on sukuk.

Malaysia and the UAE remain the most active markets for sukuk, but many other markets also seem ripe for development.

Saudi Arabia, Kuwait and Qatar, among the Gulf states, and the UK, Pakistan and Indonesia all offer strong potential going forward. Malaysia, of course, remains a sukuk powerhouse, having raised 38 issues valued at $3.77 billion this year to date, but it remains decidedly focused on a ringgit-based, local audience.

So critical is the demand for funding in the Gulf that regional corporations are shrugging off the global credit crisis and the depreciating American dollar to issue domestic-currency denominated sukuk.

"The demand for domestic-denominated bonds remains high in the GCC at present as banks remain flush with local currency with limited assets to invest in," says Nish Popat, Director of Fixed Income at National Bank of Dubai. "In addition, the continued rumour of revaluation by various central banks continues to attract foreign money into the bonds. As long as speculation remains in the region concerning revaluation, demand for local currency bonds will remain high.

The dominance of the local currency-denominated sukuk finds its origins in the weakness of the US dollar, says Mohammad Damac, ratings specialist at Standard & Poors. "It also reflects some expectations that the GCC central banks will revise their exchange rate policy. Another reason is the widening of the credit spread in the market. We expect to see more sukuk issuances in local currency, although in the long run, the dollar should return as the currency of choice."

Seeking a yield curve

While the sukuk industry has risen quickly, it has not been without its short-term hiccups and long-term challenges. Apart from the fact that the market is not immune to the global credit crises, the industry faces a number of challenges to sustain growth, such as standarisation, structure harmonisation and the availability of expertise and human capital.

For example, the Gulf and Malaysian interpretation of sukuk differ greatly and there are concerns that it will lead to a fragmentation of the industry - if it has not already.

The handful of Islamic scholars also reflects the shallow talent pool available in the industry. According to a Forbes report, there are only 20 Sharia scholars who dictate Islamic finance. Lack of scholars is not the only problem. The sheer dearth of Islamic finance professionals also means that the industry has very little talent to pick from. These issues, if not addressed soon, could derail the sukuk gravy train.

On a macroeconomic level, sukuk issuance has been on the rise in the absence of an active monetary policy in the Gulf. Most Gulf currencies are pegged to the American dollar, making GCC monetary policies subservient to the Federal Reserve. The lack of monetary instruments in the Gulf central banks' arsenal has made the development of conventional bonds difficult, although not impossible.

Faisal Hijazi, business development analyst (structured finance - Middle East and Islamic finance) at Moody's, thinks Gulf governments are less likely to issue sukuk in the short to medium term, given the robustness of their fiscal and current account surpluses. "On the contrary, GCC governments with the rising fiscal surplus are gradually reducing their sovereign debt levels."

GCC governments, represented by central banks, could step up their monetary policy operations by issuing short term liquidity sukuk instruments, similar to the Central Bank of Bahrain (CBB) monetary instruments, CBB Sukuk and Al Salaam Sukuk programmes.

"Globally, I think the governments of Japan, Hong Kong and the UK more likely to issue sovereign sukuk much earlier," says Hijazi.

Indeed, the sukuk bug is not restricted to the Gulf. In June, Indonesia decided to remove taxes on sukuk issued by the government to make their offering more attractive to foreign investors.

Meanwhile, Japan Financial Services Agency (FSA) has submitted an amendment to the banking law to the Diet (Japanese parliament) which may allow Japanese banks to offer Islamic finance products through a subsidiary, according to media reports. Hong Kong, London and Singapore are also looking to leverage their financial services hub status to attract the Islamic finance market.

"I get a call virtually every day from companies in countries as diverse as South Korea, the United States and Brazil, looking to issue sukuk and tap into the liquidity in the Gulf," says the regional CEO of one of the largest international banks based out of DIFC.

It appears that sukuk have already gone global.

Bringing Islamic finance back to its roots in a regulated manner

Islamic Finance is in vogue. Various financial centres around the world are vying with each other to assume the mantle of pre-eminence in Islamic finance, challenging upstarts with a wider variety of Islamic finance and product “innovation”.

In the Gulf, Bahrain has tried to develop such a niche, while Malaysia has been a pioneer in the Far East. But it is London, with five licensed Islamic finance institutions, that has been making the running, and the finance institutions located in that city have been vigorous in lobbying the UK government to treat Islamic finance products on a par with non-Islamic offerings.

What London seems to offer also is a high level of regulatory supervision over Islamic institutions operating in the UK. This aspect seems to have taken a bit of a knock in the Gulf over a fraud investigation at the UAE’s largest Islamic bank, Dubai Islamic Bank. However, it is from such lapses of internal controls that the Gulf regulatory authorities can learn and strengthen supervision processes to regain public trust.

While progress has been made in the UK, the most recent announcements by Alistair Darling, the chancellor of the exchequer, in the March budget statement seem to have put some of the recent momentum on hold.

What the current chancellor is expected to do – and which could give Gulf Islamic financial centres their opportunity – is to close a loophole created by his predecessor, Gordon Brown, when the UK Government was trying to make it easier for ­Muslims to buy their own homes.

UK financial watchdogs seemed to have discovered that some commercial properties were being structured to take advantage of a sharia-compliant tax break relating to stamp duty. The situation will be different after the loophole is closed. Home owners using financing compliant with sharia laws will have to pay stamp duty more than once, making it financially unattractive, but morally imperative, for those most committed to Islamic financing.

The time has come to take a step back and ask a fundamental question – is Islamic financing, as operated today, one more tranche of an innovative financing product range, or a way of life for devout Muslims? If it is the former, then it does not really matter whether Islamic financing is perceived as one more variation of ethical investment, which has long been around in the West. It then also does not really matter whether an Islamic financial centre is located in London or Paris.

If the issue is a more fundamental one, and Islamic finance is a way of life, then core Islamic product development, sharia supervision and regulatory oversight should be nearer home, in the Muslim world.

The Gulf is now awash with oil surpluses. It should not be beyond its reach to initiate world-class Islamic finance training and research centres, along with a transparent debate between the Gulf regulatory authorities, banking practitioners and sharia boards of all persuasion, whether those perceived to be more dogmatic or more “flexible” in their sharia rulings.

To its credit, the UK government has listened to all parties and established working groups to assess legal, regulatory and sharia compliance issues. The same ought to happen in the Gulf, as too often, products are launched with bewildering speed, leaving Muslim investors confused and, as illustrated in the recent fraud cases, too often without proper internal supervision.

The Bahrain Monetary Agency has been at the forefront in establishing a regulatory framework and oversight that has attracted a viable core of Islamic financial institutions to the kingdom. There is still room for more such Islamic centres and product development, including funding of endowed academic chairs in Islamic finance at major Gulf universities.

The rationale is simple: the major Islamic market, in terms of breadth of registered Islamic financial institutions, and depth in terms of potential business and deposits, is in the Arab Gulf and other Middle East countries, as evidenced by the boom in Sukuk issuance for Gulf corporates and sovereigns.

Nearly all newly licensed financial institutions and investment houses in the Gulf have adopted an Islamic character, or a preference for Islamic financing products in their portfolios. Gulf-based Islamic intellectual capital can be put to the service of other financial markets, instead of witnessing a reverse intellectual capital flow. Regionally-based sharia supervisory boards would be closer to their constituents to discuss, refine and debate new products in the Arabic language, instead of through translations, however good those might be.

At one stage, the Gulf was a mere producer of crude oil, some of which was then processed and resold back to the Gulf as finished higher value products. The day has now come for Islamic deposits to be “reprocessed” in the region, through local Islamic financial institutions, and re-exported as high value financial services to others – as long as the proper regulatory oversight is in place. This is how London became pre-eminent in providing world-class insurance and reinsurance services to the rest of the world.

Dr Mohammed Ramady is a former banker and Associate Professor, Finance and Economics at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia.

High finance

Amid continuing turmoil in global credit markets, Islamic finance is going from strength to strength. Arabian Business examines the rise of Sharia investment, and analyses the challenges ahead.

With the credit crunch and markets in the West tightening their belts, more and more attention is becoming focused on the Middle East as a source of potential revenue and growth.

And with a host of Sharia-compliant products on offer, both local and international finance houses are scrambling to secure their slice of a lucrative market.

"Islamic finance is kind of like going fishing and having a net which is able to catch all kinds of fish - if you're going fishing in the Middle East and you have Sharia-compliant financing prospects, then a lot more people will likely be able to take advantage of your products," says Oliver Agha, head of Islamic Finance at DLA Piper, the world's largest law firm.

If you've only got conventional financing products then you're limiting your business. It's like appealing to a larger audience, and from a very simple commercial perspective, that's why it's becoming attractive.

Islamic finance has grown by between 15 and 20% in each of the past three years, and since the inception of modern Islamic banking, the number and reach of Islamic financial institutions worldwide has risen from one institution in one country in 1975, to more than 300 institutions operating in more than 75 countries today.

Although Islamic banks are concentrated in the Middle East and southeast Asia, they are also niche players in Europe and the US. Islamic banking assets and assets under management now exceed US$1.7 trillion, and the Islamic finance sector is expected to reach US$2.7 trillion by 2010.

"Project financings that previously were done purely conventionally are now beginning to be done on an Islamic basis, sometimes partially and sometimes wholly," says Agha.

Across the board you're seeing Islamic financing coming into the fray - insurance for instance has grown tremendously and the premiums now are at US$2bn to US$3bn, and we expect that to go up to US$10bn in a decade.

"So in all respects as the market develops and matures, we're seeing a growth that's pretty substantial."

While Islamic finance is still a nascent industry, with a small share of the global market - about 1% - the sector is benefiting from a number of favourable structural and cyclical drivers: strong growth in the GCC and emerging market economies of Asia, positive demographics of young and rapidly growing populations, and a shift of preferences of savers and investors towards Islamic finance in Muslim countries.

There are also handsome returns to be had.

"We have found that Sharia finance doesn't just help you pick good sectors from the broad universe, but it actually helps you move a step further and pick good companies from within those sectors," Jahangir Aka, senior executive officer for SEI in the Middle East, and author of a new report entitled Sharia Investing: Beating the Credit Crunch, tells Arabian Business.

In the report released last week, The New York-based investment operations solutions firm emphasises the consistent outperformance of the MSCI World Index by the Dow Jones Islamic Developed World Index.

"Sharia-compliant structures have many screens and requirements that should be recognised as contributing to this outperformance," the report reads. "The oft-quoted aversion to the financial services sector is only one of those."

"It is a much tighter, far more regulated market [than conventional finance]," says Aka. "There are so many screens and filters, and if you're applying your Sharia guidelines and principles then you have to be doing a very, very high level of due diligence."

In addition, the leverage component of Sharia finance has played an important role in assuring the security of investments. The broad Islamic screen on equities demands low-leveraged companies, with acceptable debt-to-revenue ratio levels below 33%.

"As a result, what we have ended up picking, in terms of stocks, have actually been far, far better performers," Aka continues. "We've been managing mandates for different religions for a while, and we have been pleasantly surprised by the performance of Sharia-compliant structures.

Despite the success stories, there are challenges ahead for the Sharia finance industry.
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