Sukuk & Capital Market - Islamic Finance News

Sukuk & Capital Market - Islamic Finance News

November 2012

Sukuk &

Capital Market


Islamic PE

& VC: Still













editor’s note

Market resurgence



Nazneen Halim

Features Editor & Lauren Mcaughtry

Copy Editor

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The last year has seen unprecedented growth in the Gulf Sukuk market, with

major issuances spurring its primary Sukuk market, and new entrants such as

Turkey creating diversity in the issuance space. Although Malaysia currently

dominates the global issuance table, making up 60% of global Islamic issuances,

the challenge to attract cross-border investments and Middle East issuers still

remains a hurdle in the country’s bid to create a dynamic and internationally

attractive capital market.

For any capital market to be successful, clear laws and precedence are important

elements in attracting foreign issuers and creating a sustainable market. Past

defaults and the current global economic environment has further pushed the

need for transparency, proper regulations and clear-cut tax laws in order to attract

major issuers and to create investor confidence in the market. Diversity amongst

investors is also fundamental in avoiding too much concentration in one single

geographical area to mitigate risk from an issuer’s perspective.

Analysts have projected a continued rise in demand for Sukuk particularly in the

infrastructure and project finance space; in the GCC, Arab Spring countries and

Asia moving forward. Tapping the Sukuk market could help improve the capital

structure and liquidity profiles of GCC and Asian companies, particularly those

operating in capital-intensive industries such as infrastructure. It could also

provide such companies the longer-term funding they need via a different funding

source. This is expected to create more depth and substance in the Sukuk and

capital market space, and also ties in with the need to tether Islamic finance to

the real economy.

In this issue of Islamic Finance news Supplements, we take a comprehensive

look at the current Islamic capital market landscape; its issues and challenges,

as well as the meteoric rise in capital market issuances. We also examine the

secondary markets, which has seen development over the years, but still requires

much more attention in order to create more depth and sustainability. The private

equity and venture capital sector also take center stage in this issue; in which we

question the habits and intentions of Islamic investors who are eager to reap the

rewards but still shy away from risk.


We hope you will find this issue an informative and enjoyable read.

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November 2012 1

contents feature


4 Sukuk and the Islamic Capital Markets:

Moving Forward

As the Islamic capital market space sees new

entrants and Sukuk issuances gain momentum in

the Middle East and in emerging markets such as

Turkey and Hong Kong, Islamic finance players

look forward and seek to create a sustainable and

credible Islamic capital market to capitalize on the

influx of business.


8 Addressing Relevance

Afaq Khan, CEO of Standard Chartered Saadiq

shares his views with Islamic Finance news on the

global Islamic capital market, and prioritizing for the



11 Islamic Private Equity and Venture

Capital: Still Misunderstood?

Until issuers and investors alike accept risk sharing as

a fundamental aspect of Islamic finance, the Islamic

private equity and venture capital space will continue

to struggle.

15 Secondary Markets Stalemate?

Liquidity and the secondary market, or the lack

thereof, in the world of Islamic finance, has been an

issue of much debate for many years among industry


25 The Islamic Fund Management Industry

– Back to Basics

The Islamic fund management sector is still

grappling with fundamental challenges that could

prove to be crippling to this nascent industry.


13 A Bright Path Ahead

The outlook is favorable for Sukuk issuance in

Malaysia this year and in the future, as issuance is

expected to continue to grow exponentially.

18 Sukuk Investing: Diversification for

Resilient Performance

The 2009 Dubai debt crisis erroneously gave the

global investment community a poor impression of

Sukuk (Shariah-compliant fixed income) investing.

22 Dispute Resolution: The Final Piece of

the Puzzle

With an eye on the growing complexity and

internationalization of the Islamic finance market, The

Kuala Lumpur Regional Arbitration Center (KLRCA)

has become the first organization in the world to

launch its i-Arbitration Rules; a dispute resolution

mechanism specifically formulated for Shariah

compliant transactions.

27 Diverging Models Shape The Growth

Prospects for Takaful

The growing need for insurance that complies with

Shariah law means that the global Takaful sector is

becoming an increasingly significant niche within the

wider insurance industry.

2 November 2012

Cover story

Sukuk and the Islamic Capital

Markets: Moving Forward

As the Islamic capital market space sees new entrants and Sukuk

issuances gain momentum in the Middle East and in emerging markets

such as Turkey and Hong Kong, Islamic finance players seek to create

a sustainable and credible Islamic capital market to capitalize on the

influx of business. NAZNEEN HALIM explores the current issues in the

market and challenges moving forward.

Although Sukuk remains the buzzword particularly in Asia and

the GCC, industry players have begun to place more emphasis

on products and structures beyond the traditional debt capital

market instruments, looking to incorporate Islamic finance

into the real economy via project and infrastructure financing

structures, increasing trade finance and syndication activity,

and most importantly realizing the need to underpin Islamic

finance transactions to real and tangible assets.

For the last ten years, Sukuk has been one of the main drivers

in the industry. However, industry players have been urged to

take a macro perspective on the Islamic finance industry and

help it find place in the global economy. As a result, the Arab

Spring countries have taken center stage in the bid to venture

into new, untapped markets with an opportunity to directly link

infrastructure building and development to Islamic finance.

Usman Ahmed, the head of corporate and investment banking

at Citibank in the Philippines, believes that an important

driver of sustainability in the market is the integration of

Islamic finance within existing markets and the development

of new products. The global financial crisis has also served

as a wake-up call at the very least to the Islamic finance

industry as a whole, creating further need for regulatory

supervision, transparency in documentation and structures,

as well as sound capitalization in the banking and financial


As an instrument that allows medium-term capital raising, the

popularity of Sukuk amongst capital market players—both

Islamic and conventional— has become more prevalent. The

growing desire for jurisdictions to issue sovereign Sukuk to

diversify their investor pool and attract liquidity from the Islamic

world is constantly reflected by the entry of new markets; with

the most recent being Turkey, which had issued its debut

US$500 million Sukuk, attracting over five times its initial

issuance target.

Malaysia leads the way

Malaysia is currently touted as the most favored destination

for issuers in the Sukuk market dominating 60% of the global

share worth US$100 billion. This is primarily due to its deep

and broad market with comprehensive regulations that ease

Sukuk issuances, a favorable tax regime, a sophisticated

investor base as well as support from all issuers, regulators

and investors. However, the lack of an available platform in the

Islamic capital markets outside of Malaysia and Saudi Arabia,

as well as cross-border transactions involving swapping the

ringgit to the currency of the issuer still remain a concern in the


4 November 2012

Cover story

From a foreign issuer’s perspective, Sabri Ulus, the head of

treasury at Bank Islam Brunei Darussalam, is full of praise for

the Malaysian Sukuk market, particularly due to its government

and regulatory support, as well as its “very sophisticated”

investor base. He added: “There are also many Islamic financial

institutions, regulatory organizations and standard-setting

bodies. GCC entities come to Malaysia and issue ringgit Sukuk

mostly due to the premium on cross-currency swaps, thus

reducing their costs if they issue in Malaysia. The tax regime

and regulatory environment is also very encouraging to foreign

companies to issue in the ringgit market.”

Afaq Khan (caricature below), CEO of Standard Chartered

Saadiq believes that clear laws and precedence are key to

the success of any capital market in attracting cross-border

issuances; a feat Malaysia has achieved over a decade of

fine-tuning its Islamic capital market laws. “It is always a big

concern for issuers when they want to come to a new market

to issue paper. Malaysia’s regulations make it easy for the

Middle East issuers to come to a new legal jurisdiction, and the

ringgit market remains the most liquid in the Sukuk industry,

so Middle East issuers are confident they can meet their issue

size requirements by coming to the ringgit market as opposed

to going to any other regional currency.”

However, he adds that the main drawback of the ringgit market

is its failure to meet the requirements of most international

issuers in terms of currency. “The need of the issuer isn’t

exactly in the ringgit currency, and it has to be swapped

back into the currency which the issuer can use in their day

to day business. Sometimes you will see Sukuk issuances

in the ringgit market go up, or some taper off. At the back of

this there really is no concern. It is simple economics; once

they (the issuer) swap into a currency they can use, can it still

be considered a competitive financing for them? That is what

drives the issuances from the Middle East to the ringgit market;

when it is viable for them to competitively tap

this liquid and growing market.”

Another fundamental to Malaysia’s

popularity as an up and coming

jurisdiction for cross-border deals

involving Middle East entities is

its legal system, which is based

on Common law. Saad Rahman,

the executive director for global

Islamic banking at Credit Agricole

explains: “Most cross-border deals

are based on English, New York

or Texas law. As an issuer, you are

looking for transparency of contracts,

proper enforcement, and to seek

satisfaction under the enforcement; and

you get that under English law more

than civil law. There is a precedence

which exists in more codified forms of

law. As an investor and issuer you want

robustness of the contract and a legal

jurisdiction that gives you comfort on

both sides when it comes to a crossborder


Badlisyah Abdul Ghani (caricature

right), CEO of CIMB Islamic believes

that it is imperative for the industry

to take a step back and evaluate its

position in the market. “Outside of

Malaysia, the Islamic capital markets

in other jurisdictions need to be aware

of the need to chart greater growth in

the future, and to create a platform

that will ensure success. In my

opinion, the infrastructure in

the global Islamic capital

markets is already there: with

RegS and 144A regulations

in place, however, from a

jurisdictional perspective, it is

unstable to rely on the global

market at all times.”

He added: “The framework is

available and the liquidity is

there. But as a nation, you do

not have control over the global

market, which creates instability.

What we want as a player is to be

able to go into a particular jurisdiction and to do transactions

in the local currency. Because in the long-run, that would be

more stable for issuers in terms of ability to tap the currency

that they require in a particular jurisdiction. As CIMB Islamic

try and facilitate issuers and issue Sukuk globally, we always

advise the issuer to do it in their local currency first, then in US

dollars. Outside of Malaysia and Saudi Arabia however, there is

currently no local currency market.”

Change in mindset

It has been said time and again that Islamic investors are

incredibly risk-averse, which in reality goes against the main

tenets of Islamic finance which promotes the sharing of risk.

This has proven to be a major drawback for the Islamic capital

markets, especially in its bid to create a more equity-based

issuance and investment environment.

According to Usman, innovation and growth can only

be achieved if the industry moves beyond fixed-income

instruments and embodies the true spirit of Shariah financing;

which involves the willingness to take up equity-type risk. “In

the capital markets we have only just scratched the surface

by relatively integrating Islamic finance with fixed-income

instruments. However, we haven’t even explored truly assetbacked

securities, infrastructure financing and equity-linked

issuances. It is important to understand first what differentiates

Riba from profit. It is the risk related to ownership; and therefore

we have to take real risk, relate to ownership of assets.

“We are still very far from the true spirit of Islamic finance,

and that is exactly what is holding us back in terms of the

development of new instruments. The whole world will open

up to us if we are willing to take equity-type risk. Fixed-income

Sukuk should just be seen as a means to an end. Issuers

should be encouraged to do Sukuk issuances because then

their equity will become Shariah compliant, and if they do a

November 2012 5

Cover story

debt on a Shariah compliant basis, they will be able to tap into

a much bigger equity investor base that will come from the

Islamic finance market. Islamic investments have to be coupled

with risk-taking appetite.”

Market challenges and moving forward

The all-time low yields currently being experienced by Middle

East issuers is seen as a catch-22 amongst some industry

players. Although it has attracted an unprecedented number of

issuers to the market, some worry that the market will become

hollow once this low-yield run ends.

Sabri notes that: “As a treasurer, it is important to keep in mind

that although the cost of funding is very low today, it might not

stay the same for the next five to ten years. This is worrying

if you are tapping into the market with low-yield Sukuk. At

present, most conventional issuers are shortening their

borrowing from the market, because they can’t find investors,

and even if they can, the price of the conventional bond is very

high. For instance, Spain’s sovereign bond saw a pricing of 3%

compared to Turkey’s debut sovereign Sukuk; which was below

investment grade paper, but priced at 2.8%. On the other hand,

it is encouraging to see the Sukuk investor base evolve to almost

a 50-50 share between conventional and Islamic investors. We

are seeing conventional pension funds and banks subscribe to

Islamic paper mainly because for issuers, from a credit-rating

and cash flow perspective, Sukuk is more reliable than the

conventional or European issuances at present.”

Although the recent impact from Dana Gas’ inability to meet

its Sukuk repayment deadline on the 31 st October for its US$1

billion issuance has yet to be thoroughly explored, industry

players are clearly divided. On one hand, many believe that

Dana Gas’ standstill with its creditors is just a mere hiccup in

the Islamic finance capital market space, and on the other,

some worry that this might have a spillover effect into the UAE

Islamic issuance market and deflate any ambition of a market

resurgence in the Middle East.

Khalid Howladar, vice president/ senior credit officer at Moody’s

believes that the market was already primed on the Dana Gas

situation and a possibility of a default, in the several months

leading up to the standstill; thus eliminating the shock factor

which is usually the main reason for panic in the market. He

said: “Dana Gas has been in trouble for a while, so it’s not really

a shock. The market was already aware of the situation, unlike

the Dubai World/Nakheel Sukuk— which was a bit of a surprise

at that time. Broadly, the UAE market is recovering, and the

economy is much better. So this is just a small piece of bad

news in what is overall a much improved credit environment.

So, I don’t think it is that significant. In terms of the Sukuk

market, it’s not so much a negative signal about Sukuk, and

it’s more about the company, so I don’t think it would affect the

Sukuk market that much.”

In terms of its effects on the credibility of the UAE credit

market, Khalid believes that there are more pressing issues

at the moment, including Dubai Holdings’ current financial

woes: “There are still bigger problems outstanding such as the

companies of Dubai Holdings that are under restructuring. It

has been a year but there is still no resolution on that. That’s a

much bigger story and in terms of exposure in the market, that

will have more of an impact. This (Dana Gas) is relatively small

at US$920 million and the banking system is well capitalized

and liquid.”

The lessons to be taken from this nail-biting experience, Khalid

believes, are aplenty: “From an issuer’s perspective, companies

need to look at their capital structure and take on debt based

on solid cash flow projections. I think they need to take a more

conservative approach to future cash flow forecasting to ensure

that they can pay back all the debt borrowed and not be carried

away by the boom times. Investors on the other hand need to

study the company, their cash flows and the ratings they get,

and make sure they understand the risks in the bond… such

as, will the company be able to pay me back in bad times as

well as good times? People need to do their due diligence in

these investments to make sure that the company is in a strong

position to pay back the money that they borrow.”

As the market evolves and the industry becomes clearer of

its goals and objectives, market players are becoming more

perceptive of what investors want and what motivates bankers

to become part of the growing global Islamic finance movement.

“From an issuer’s perspective, their primary objective is to

tap liquidity, build a profile with investors they haven’t really

explored before, and ensure diversity of their funding base. At

the heart of every Islamic capital market issuance is the desire

to get core Islamic demand from issuing an Islamic finance

transaction. Sustainability has to be driven by the ability and the

increased participation of Islamic banks to anchor a transaction

that is issued in a Shariah compliant manner,” said Usman.

He added: “Transactions are substantially driven by demand

from non-Islamic banks and conventional investors, and that

should encourage more issuers to look at the Islamic market.

It is primarily a case of investor demand driving sustainability.”

According to Saad, it is important to bear in mind that the Islamic

capital markets is far from isolated from the conventional space,

and that Islamic finance exists in a greater credit model of global

liquidity. “We are still working in a very much conventional

environment and issues in this market have a direct impact on

the Islamic finance industry. For instance, in terms of Sukuk,

many times it is the conventional investor who drives the

pricing down, and although this is to the benefit of issuer, it

does not necessarily bode well for the Islamic investor looking

to come into the deal. Islamic finance cannot be a standalone




November 2012


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act as a fiduciary or an investment advisor except where registered as such.


Addressing Relevance

Afaq Khan, CEO of Standard Chartered Saadiq shares his views with

Islamic Finance news on the global Islamic capital market, and

prioritizing for the future.

Standard Chartered Saadiq, ever since its inception in 2004,

has come leaps and bounds in the global Islamic banking and

finance space. The bank, which has successfully remained

on track in terms of fulfilling its clients’ needs and providing

them with a complete suite of Islamic products for end-to-end

solutions is also a major player in the Islamic capital markets

space; having been involved in landmark Sukuk deals this

year, including the Qatar Government’s US$4 billion issuance

and Abu Dhabi National Energy’s RM650 million (US$213.07

million) innovative cross-border transaction.

Although Sukuk is a good

proxy for the health of

the industry, we should be very

careful. It is not the only


“This year we have had two significant milestones: we

launched a global private banking business recently, and

also launched the Islamic Euro Clearing Account in Turkey

in September this year. This has been very well-received

in the market, and we are constantly looking to expand by

products, businesses and geographies. Overall, the journey

has been very rewarding. We have a very cohesive, clientcentric

mandate to serve our clients, to offer a complete Islamic

banking alternative product suite to meet the end-to-end

requirements of our clients,” Afaq said.

However, despite the bank’s many successes in arranging

major Islamic capital market deals throughout the year, and

a healthy deal pipeline moving forward, Afaq insists that the

bank’s priorities extend beyond Sukuk. “Although Sukuk is a

good proxy for the health of the industry, we should be very

careful. It is not the only proxy. Islamic banking is an alternative

to the entire conventional banking space. In the conventional

banking space, nobody says that if the capital markets are

down, then the entire banking system is down. The same

applies to Islamic banking. Trade finance and syndication are

also growing sectors.”

Sukuk in itself is an instrument that allows medium-term capital

raising. As and when the clients need medium-term capital, they

currently have three options: to do bilateral financing, go to the

syndications market, or go to the Sukuk market. But that is only

a small part of it, clients are constantly doing treasury activities,

buying products, using Islamic banks, doing trade finance and

cash management activities too,” he added.

Afaq also warns that most of the Islamic capital market activity

moving forward hinges on the global economy, and to an extent,

the outcome of the Eurozone crisis. He said: “I am optimistic

for next year’s issuances, but a lot depends on what happens

to the global economy. This is because medium-term capital

is raised for expansion or new projects, for restructuring and

lowering cost of capital. And if everyone has refinanced and

lowered their cost of capital, then there is no need for them to

keep coming to the market.”

8 November 2012


What the market needs, Afaq says, are more players issuing

paper in order to expand the current issuer base: “The market

needs more players to issue paper. We were very excited that

the government of Turkey had recently issued a sovereign, and

I believe that Malaysia and Indonesia should become repeat

issuers in the market, and new counterparts should also look to

enter the Sukuk market. This is because banks have regulatory

limits on how much exposure they can have to each client as a

proportion of their capital. Therefore we need the issuer base

to expand.”

Islamic treasury: Area of focus

Based on the current issuer and investor trend, particularly

in the GCC and Malaysia, it is evident that there is ample

liquidity to be tapped in the market, and there is still much

Shariah compliant liquidity looking for Islamic assets to invest

in. However, this can only be engaged effectively with the

proper deployment of Islamic treasury products, including risk


Afaq explained: “We are very focused on risk management,

because I believe it is very important to manage risk as the

industry grows in size and scale. In the real economy, Islamic

banking is exposed to these risks, and it is important to keep in

mind that derivatives are not for speculative purposes, and are

essentially restricted to hedging purposes. Risk management

is a very important catalyst to the growth of Islamic finance

as the product suite grows and the gap between conventional

and Islamic finance is breached. Innovation and product

development will remain a key growth driver for the next decade

for Islamic banking. For us to become relevant to the needs of

society and the economy, we must meet the needs of society

and the economy.”

I believe it is very

important to manage risk

as the industry grows in

size and scale

According to Afaq, there are currently two types of treasury

products in the market; one is for the money-market, in which

Malaysia has taken the lead in terms of having a complete

product suite, and was generally a pioneer in this area with

support from Bank Negara Malaysia. “The progress is good

in this area, as a lot of other countries such as the UAE and

Pakistan have now started issuing money-market products,

and the International Islamic Liquidity Management Corporation

(IILM) has also begun work in this area. These are all important


“Because we operate in the real economy, we are exposed to

the risks in the real economy whether it is exchange rate risk,

yield curve risk, etc.- these are facts of the economy. And this

is true from the perspective of the bank’s balance sheet and

our clients’ viewpoint; because our clients are also exposed

to these risks and need to hedge them. We currently have a

comprehensive product suite covering currencies, rates and

commodities hedging solutions. I believe these are important

for the corporates, because we are offering them end-to-end

solutions, and for Islamic banks, because they are growing

in size, and becoming material to the banking system in the

country. Therefore, they must have risk management tools

to manage the risk. For instance, Malaysia’s Islamic banking

sector currently stands at 20%, and there are aspirations to

double this figure. However, this cannot be done without risk

management tools. We are very focused on this, and it is

essential to the growth of the Islamic market, where we have

balanced growth, with business and risk going hand in hand,”

he added.

Industry initiatives

Afaq believes that the industry is currently already committed to

grow Islamic treasury and risk management products, with the

International Islamic Financial Market (IIFM) actively involved

in drafting standardized commodity Murabahah, and profit-rate

swap documents. “Standard Chartered was on the working

committee for these standards, and as the market grows, these

standards will start as best practice, and then the market will

use them as the base document and either adopt them or

tweak them based on local norms and local regulations. It is

a very good start. We believe that this whole area needs more

attention and more exposure.”

New frontiers

In terms of new markets, Standard Chartered has revealed

its aspirations to tap into the African Islamic banking space in

the medium-term. “The market is growing, and we are excited

about the market there. There has to be a change in regulations

in some markets, and we are currently studying the prospects

there. To successfully launch in the country, you need a

regulatory and legal framework in place. We are currently

talking to different stakeholders in Africa, and as Standard

Chartered is very client-centric, we will choose which products

to launch based on the feedback we receive from the clients.”

Afaq also believes that there is much potential amongst the

Arab Spring countries such as Egypt and Libya. There is a great

opportunity for these countries to rebuild, and Islamic banking

is looking for new markets. Therefore, it appears to be a perfect

match. What timeframe the regulations will be passed and how

welcoming they will be in terms of giving licenses remains to be

seen; but clearly there are opportunities due to their proximity


to the Middle East and a common language.”

Afaq Khan

Chief executive officer

Standard Chartered Saadiq

Building One, DIFC Gate Precinct

Dubai International Financial Centre

Dubai, UAE




November 2012 9

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Islamic Private Equity and Venture

Capital: Still Misunderstood?

Until issuers and investors alike accept risk sharing as a fundamental

aspect of Islamic finance, the Islamic private equity and venture capital

space will continue to struggle. NAZNEEN HALIM studies the prospects

of this virtually non-existent sector and its potential contribution to

the Islamic finance industry as a whole.

At present, industry experts unanimously agree that investments

in private equity and venture capital in the Shariah compliant

universe are almost zero. Despite the myriad of family-owned

businesses and start-ups in Islamic finance strongholds in the

Middle East and Asia, investments in Islamic private equity

have been dismal to say the least.

Opportunities in this sector also extend beyond these two

regions, into countries such as Germany where SME businesses

and start-ups are well-regulated and a common phenomenon.

Considering the continuous calls for Islamic liquidity and

investments to be channelled into real economic activity, and

for the sharing of risk and rewards in a Shariah compliant

transaction, it is ironic that this sector remains dormant as

private equity and venture capital investments are the perfect

fit for the Shariah compliant investment universe.

Amongst the most common structures prescribed for investing

in Islamic private equity and venture capital are Mudarabah,

Musharakah and Wakalah. These structures involve profit

sharing (Mudarabah), partnership between two parties

(Musharakah) and the use of an agent to act on behalf of the

principal (Wakalah). In a Mudarabah arrangement, a contract

is made between two parties to finance a business venture.

The parties are a Rab al maal (investor) who solely provides

November 2012 11


the capital and Mudarib (entrepreneur) who solely manages the


Ahmad Lutfi Abdul Mutallip, a partner of global financial services

and Islamic banking at Azmi & Associates, wrote: “This is akin

to a conventional PE/VC, where there exists a relationship

between the capital provider and the entrepreneur. If the venture

is profitable, the profit will be distributed based on a pre-agreed

ratio. In the event of a business loss, it should be borne solely

by the capital provider, to the extent of the capital contribution

while the entrepreneur will lose his time and effort. The key to a

Mudarabah structure is the fact that the entrepreneur cannot be

placed at risk to bear losses, unless proven negligent.”

In Malaysia, the Securities Commission issued guidelines

and best practices for Islamic venture Capital in March 2008,

solidifying the regulator’s support for the sector. The guidelines

specify the core requirements for establishing an Islamic venture

capital corporation or an Islamic venture capital management

corporation, and set out the best practices intended to assist

such corporations in carrying out Islamic venture capital


According to the guidelines’ core requirements, the

corporation must first be registered under the Guidelines for

the Registration of Venture Capital Corporations and Venture

Capital Management Corporations issued by the Securities

Commission. In addition, all activities of the VCC and VCMC

must be Shariah compliant, and an independent Shariah

advisor must be appointed to ensure adherence to the Shariah.

The Shariah advisor is also expected to disclose, on an annual

basis, and declare to the board of directors of the Islamic private

equity/ venture capital fund company that the Islamic private

equity/ venture capital fund company is managed according to

Shariah principles.

The Shariah advisor is also expected to endorse any investment

decision and to ensure that the activities of the investee

companies remain Shariah compliant right to the point of full


The key to a Mudarabah

structure is the fact that

the entrepreneur cannot be placed

at risk to bear losses,

unless proven negligent

According to Lutfi, the four key considerations involving

the investment into Islamic private equity/ venture capital

companies include Shariah compliant documentation, financing

and investment structures; Shariah compliant underlying

assets and investments; legal documentation, which includes

the powers of the Shariah advisor; and an express provision

and understanding between the parties involved that any profit

of the Islamic private equity/ venture capital fund company

shall be based on returns from investment of the fund, with no

guaranteed profit return and there should also be a provision for

reinvestment of profits into the Islamic private equity/ venture

capital fund company.

What is needed now to create some sort of momentum in

the Islamic private equity and venture capital space – apart

from a change of mindset amongst Islamic investors – is

regulatory support; particularly in ensuring transparency and

proper regulation of these companies, the creation of attractive

and innovative structures to encourage investments, the

establishment of legal and regulatory frameworks, as well as


guidelines specific to this sector across the board.

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12 November 2012


A Bright Path Ahead

The outlook is favorable for Sukuk issuance in Malaysia this year and

in the future, as issuance is expected to continue to grow exponentially.

External economic shocks such as the Eurozone crisis are not likely to

affect the domestic Sukuk market due to ample liquidity, but will have

an impact on the international capital markets.

Malaysia maintained its pole position with 71% of Sukuk issued,

followed by Saudi Arabia with 15% .

In addition, global Sukuk issuance in the first quarter of 2012

reached US$43.5 billion, up by an impressive 55% from the

corresponding period last year.

According to Zulkifli Ishak, CEO of Eastspring Al-Wara’

Investments (formerly known as Prudential Al-Wara’ Asset

Management), Malaysia will continue to lead the market

as the world’s largest Sukuk center. The latest issue of

Malaysia’s sovereign Sukuk earned a strong response and was

oversubscribed by almost five times.

At the same time, there has been a marginal downside to Sukuk

in that there are default cases in Malaysia and other countries.

But these isolated cases are not likely to dampen sentiment for

Sukuk in future.

Elaborating on this, Zulkifli says: “Standing true to Islamic

principles, Sukuk are perceived to be ethically protected from

turning bad. However, when Sukuk defaults were scrutinized by

the practitioners and academicians, concerns were raised on

the reliability of their structures and Shariah supervision. This

has created the perception that Sukuk may not be any safer

than conventional bonds in terms of investor protection and the

treatment of defaults.”

On a brighter note, unlike the high profile default and neardefault

cases in the Middle East, Malaysia’s Sukuk defaults

have received less criticism and scrutiny from global industry


Some reasons for this are Malaysia’s robust supervisory

structure, established governance and disclosure standards;

and the highly developed legal framework and court system

which provide the necessary protection and comfort to investors.

November 2012 13


A default occurs due to the breach of binding obligations under

the original terms of the agreement between the issuer and

the Sukukholders. Both contractual parties must fulfill their

obligations under the contract or agreement. The level of

investor protection provided by a Sukuk structure is a factor

in credit assessment, but from a rating perspective, assessing

the issuer’s inherent credit strength is fundamental to the final

rating outcome. In other words, the financial and operating

outlook of the Sukuk issuer highly affects the final rating on the

Sukuk itself.

The Accounting and Auditing Organization for Islamic Financial

Institutions (AAOIFI) guidelines emphasize the difference

between Sukuk and conventional bonds. These guidelines

show that Sukuk does not represent a debt owed to the

certificateholder by the issuer, so that the owners share the

returns and the losses.

De-mystifying Sukuk

The most common Sukuk issued in Malaysia are Sukuk

Musharakah and Sukuk BBA. Sukuk BBA were the Sukuk most

issued in Malaysia in 2004, before the Malaysian Sukuk market

got dominated by Sukuk Musharakah beginning 2006.

Sukuk are not similar to bonds because the latter represents a

debt obligation of the issuer. It is created to service the need

for working capital or to re-finance existing debt, normally to

be used in the transportation sector, especially in the shipping

and aircraft sectors, real estate, construction, and also for

petrochemical projects.

Despite the wide variance in ratings, the default rate for

Malaysian Sukuk in 2009 was relatively low at 0.46% . Between

1997-2010, there were 24 cases of Sukuk default. Most were

mainly structured based on Murabahah and BBA contracts – 12

on Murabahah, 11 BBA, and only one on Ijarah.

Industry experts maintain that Sukuk defaults in Malaysia will

not pose a significant threat to the local capital market; however,

they may have a slight impact on the overall reputation of

Malaysia as the hub for global Islamic finance.

“We are optimistic about the performance of Sukuk in Malaysia

and the rest of the world. And we will highlight the positive

points of diversification to our investors,” concluded Zulkifli.

According to Securities Commission Malaysia, total outstanding

global Sukuk amounted to US$243 billion as at June 2012,


with Malaysia continuing to be in the forefront of the market.

Zulkifli Ishak

Chief executive officer

Eastspring Al-Wara’ Investments Berhad

(formerly known as Prudential Al-Wara’ Asset Management Berhad)

Level 12, Menara Prudential, Jalan Sultan Ismail, 50250

Kuala Lumpur, Malaysia

Tel: +603 2072 8808


14 November 2012


Secondary Markets Stalemate?

Liquidity and the secondary market, or the lack thereof, in the Islamic

finance industry, has been hot on the lips of industry players since the

inception of the Islamic capital markets. A lackluster secondary market

has had an effect on the overall growth of the industry, particularly in

the long-term, NAZNEEN HALIM discovers.

The Islamic investor is known for his penchant to buy-to-hold

papers to maturity, which is perhaps one of the main reasons for

the current tepid movement in the secondary markets. Driven

by the mechanics of supply and demand, pricing in the Islamic

secondary market has also been relatively disappointing as the

buy-to-hold mentality and a limited diversity of Sukuk investors

have inhibited efficient price discovery.

Despite efforts from central banks such as the Central Bank of

Bahrain and Bank Negara Malaysia to drive secondary market

growth – through the issuance of short-term paper and the

establishment of the International Islamic Liquidity Management

center, which is meant to facilitate more efficient and effective

global liquidity management solutions for Islamic financial

institutions and to create greater cross-border investments; the

money market has yet to truly yield the results of these efforts.

In a paper by the IMF entitled: “Islamic bond issuance – what

sovereign debt managers need to know” it was suggested that

the development of a liquid secondary market will depend on

Shariah compliant short-term liquidity facilities and Sukuk as an

interbank money market instruments. It said: “Given the current

short-term nature of bank liabilities, the creation of money

market instruments, and asset securitization with shorter

maturities should help to encourage a secondary market for

Sukuk. Although Islamic banks are currently one of the largest

buyers of Shariah compliant products (with long maturities),

they would benefit most from issues at shorter tenors.

November 2012 15


Short-term Sukuk could serve as money market instruments for

liquidity management purposes. Malaysia and Bahrain are the

only Muslim countries that have developed an active interbank

market. Since 2001, the Central Bank of Bahrain has issued

short-term Sukuk of either three- or six-month maturities (in

addition to medium- and long-term notes). In the GCC, 20%

over-subscription for these Sukuk indicates the substantial

demand for a Shariah compliant interbank market. In Malaysia,

similar considerations apply to Government Investment Issues

(GII) and Bank Negara Malaysia Negotiable Notes (BNNN).

Alternatively, banks can resort to asset securitization in order to

transform the proceeds from Islamic contracts into customized

capital market securities with variable maturities. One such

transaction was completed in July 2005 by Cagamas, the

National Mortgage Corporation of Malaysia, when it issued the

first Islamic mortgage-based securities as Mudarabah bonds

with varying returns and maturities, ranging from three to 20


A silver lining to have emerged this year is the increased

utilization of Sukuk for the funding of project finance and

infrastructure development in Asia and the Arab world. Issuers

are also beginning to look into new, previously untapped

markets to access Islamic liquidity and plug the demand gap for

more Shariah compliant paper linked to the real economy. An

industry player based in Dubai revealed that at present, there

is simply not enough Shariah compliant paper in the market

to fulfil investor appetite, and that issuances from highly-rated

issuers and sovereigns are still few and far between. “The

outcome of this is that Islamic investors are unable to purchase

enough Sukuk, and this supply and demand imbalance has

caused Sukuk-holders to feel unwilling to trade out of a position

for fear of not finding another Sukuk of similar credentials to

invest in,” he said.

A difference in opinion amongst scholars with regards to the

Shariah compliance of Islamic paper and their acceptability

has also been a reason for the lack of cross-border trading

across jurisdictions, causing a lack of diversity amongst

investors and creating a homogenous and largely domestic

trading environment. Dominic Harvey, project finance partner

at Vinson & Elkins, and Barry Cosgrave, finance associate at

the same firm wrote in a paper: “Barriers to secondary market

trading are not the result of a lack of effective valuation alone;

there are also other considerations relating to differences of

opinion among scholars as to the acceptability or not of certain

structures. It is possible that certain investors shy away from

secondary market trading because of a lack of clarity as to the

acceptability or not of the transaction structure employed. Were

a scholar to rule against a particular structure, and a secondary

market trade to be sought to be unwound, it would cause huge

complications both on a practical level and from the point of

view of market reaction.”

A lack of mark to market (MTM) valuations for Sukuk, which

became apparent over the last few years as a result of the

restructuring activities in the Middle East has also impacted

the Islamic secondary market. Harvey and Cosgrave wrote:

“As balance sheets became distressed over the past few

years and options to restructure were being explored, one of

the factors that caught a number of restructuring advisors from

conventional markets off guard was this lack of MTM valuation.

This led to difficult conversations with certain creditors when

‘hair cuts’ were being discussed.

A lack of MTM valuation also impacts secondary markets as

it does not establish any sort of profit-making opportunity for

traders. Without effective valuation of Sukuk there is no way to

establish a market and as a result trading does not happen.”

The growth of the Islamic secondary market requires a

collective effort amongst all the stakeholders of the Islamic

finance industry; from central banks propagating high-quality

short-term paper and encouraging the growth of the inter-bank

money market, bourses working to encourage trading through

Shariah compliant trading platforms, standardization and

agreement amongst scholars to create universally accepted

papers to increase investor diversity on a global scale, and

the creation of effective risk management tools to engage the


otherwise risk-averse Islamic investor.


November 2012


The most recognized brand in the Islamic finance events sector, the IFN Forum,

returns in 2013 with an extended agenda.

In addition to the 8 th IFN Asia, the 3 rd IFN Europe, the 2 nd IFN Indonesia,

and the 2 nd IFN Saudi Arabia – in 2013 we will host the inaugural IFN

Africa Forum.

• IFN Indonesia Forum

15 th & 16 th April

• IFN Europe Forum

21 st & 22 nd May

• IFN Africa Forum

27 th & 28 th June

• IFN Asia Forum

21 st & 22 nd October

• IFN Saudi Arabia Forum

18 th & 19 th November

The renowned ‘Issuers & Investors’ format will again feature at

all IFN Forums ensuring both buy-side and sell-side are fully

incorporated in these two day events.

With complimentary delegate passes for all issuers,

investors, regulators and other senior and relevant key

practitioners, the IFN Forum series provides you with

opportunities no other events can.

Through a series of exclusive regulatory and

country presentations, practitioner-led roundtable

discussions, non-debatable power

presentations, original case studies and

sector focused side sessions; the IFN

Forums in 2013 will again be the key,

must-attend industry events for issuers,

investors, regulators and all financial

intermediaries involved in the Islamic

financial markets with any interest in

tapping the Islamic markets.


Sukuk Investing: Diversification for

Resilient Performance

The 2009 Dubai debt crisis erroneously gave the global investment

community a poor impression of Sukuk (Shariah-compliant fixed

income) investing. Having fully recovered from this, the Sukuk market

performance has proved resilient for the past two years. Sukuk

investing not only enhances potential returns relative to conventional

fixed income investing but also reduces portfolio volatility.

This article will shed light on how Sukuk investing offers

diversification benefits by examining the investment universe,

sector weightings and country spread. It will conclude with

a case study of how investors who have limited themselves

to investing in the conventional fixed income asset class can

definitively add value to their portfolios by allocating a portion

to the Sukuk investment universe.

The Dow Jones Sukuk Index (DJSI), designed to measure

the performance of global Sukuk, comprised merely seven

constituents when it was first introduced in October 2005. At

that time, the index lacked breadth and depth in comparison

to the conventional bond index, the World Broad Investment

Grade Bond Index (WBIG). The 2008 global financial crisis and

2009 Dubai debt crisis were the first real tests for Sukuk. The

combined headwinds proved damaging to the nascent Sukuk

market and several issuances slumped to their lowest level

during these crises. However, in spite of the challenges, or

because of them, the Sukuk investment universe has staged

a strong comeback since 2009, and has reestablished itself

as a vibrant and attractive new asset class today. The DJSI

has not only improved from the unimpressive performance of

its five and seven-year returns, but it also went on to produce

superior returns by outperforming the conventional index

over a two-year time period as at the end of September 2012.

Table 1: Annualized returns of DJSI and WBIG

Annualised Returns

2-year 5-year 7-year

Dow Jones Sukuk Index 6.27% 4.87% 4.63%

World Broad Investment Grade 4.52% 5.55% 5.17%

(WBIG) Bond Index

Source: Bloomberg and CIMB-Principal Islamic Asset Management as

at end-September 2012.

Repeat of the Dubai debt crisis unlikely

With Dubai and state-controlled Dubai corporates being early

entrants as issuers in the Sukuk market, Dubai’s 2009 crisis

reverberated forcefully into the Sukuk space. With the onset

of the global financial crisis that adversely affected economies

everywhere, Dubai’s real estate market declined after a sixyear

boom. On the 24 th November 2009, state-controlled

Dubai World rattled financial markets by announcing that it

was seeking to delay payments on US$59 billion of debt 1 . The

collapse of the real estate market in Dubai severely affected

the mortgage sector and hence, the broader Dubai economy.

Uncertainties surrounding how the Sukuk securities would fare,

caused many global investors to flock to what they viewed as

the comparative safety of conventional fixed income.

Chart 1: Sept 2005 — Sept 2012 (7 years)


Dubai crisis








Source: Bloomberg



However, investor fears in the 2009 Sukuk market proved to

be unfounded. Dubai did not actually default on its public debt.

In fact, Dubai received financial assistance from Abu Dhabi,

the ‘patriarch’ of the UAE. In similar fashion to what investors

had seen related to the global banking firms a year earlier, Abu

Dhabi stepped in to support Dubai with a US$20 billion bailout 2 .

Following the extension of financial support to Dubai from

Abu Dhabi, the Government of Dubai made concerted efforts

to strengthen its banking system by implementing a scoring

system to evaluate individual borrowers’ creditworthiness.

In addition, the Gulf Cooperation Council (GCC) banks have

made a variety of efforts to strengthen their balance sheets

to protect against declines in loan recovery rates and asset

prices. The banks’ tier 1 capital adequacy ratios have steadily

increased over the last four years and were in the region of

15% at end-2011. More importantly, equity forms the bulk of the

banks’ capital base, and their equity-to-assets ratios are high,

ranging from 10% in Bahrain to 16% in Qatar 3 .







18 November 2012


Global Sukuk makes a high quality recovery

The DJSI has recovered completely from the crisis. The index

has matured with respect to both the quality and quantity of

its constituents. This has led to markedly lower volatility given

the higher creditworthiness of the investment universe. The

returns volatility of the DJSI has fallen significantly to 2.08%

for the two-year period compared to the five and seven-year

periods of 10.13% and 8.58% respectively. At 2.08% the return

volatility in the Sukuk space is less than half of that in the

conventional space over the same period, which registered

at 5.16% for the WBIG. This lower volatility is coupled with a

tripling of the number of constituents in the index, meaning that

a severe fluctuation of any one constituent has less singular

effect on the overall index.

Table 2: Returns volatility of DJSI and WBIG

Returns Volatility

2-year 5-year 7-year

Dow Jones Sukuk Index 2.08% 10.13% 8.58%

World Broad Investment Grade 5.16% 6.29% 5.99%

(WBIG) Bond Index

Source: Bloomberg and CIMB-Principal Islamic Asset Management as

at end-September 2012

A further examination of the DJSI’s returns reveals a significant

increase in the Sharpe Ratio, a measure commonly used to

better analyze performance by taking risk into consideration.

A portfolio with a higher Sharpe Ratio is considered to have

exhibited better performance as the Sharpe Ratio measures

how well the return of an asset compensates the investor for

the risk taken.

The Sharpe Ratio for the DJSI is 2.96 over the most recent two

year period, versus 0.47 and 0.53 over the five and seven-year

periods respectively. In contrast, the Sharpe Ratio of the WBIG

remained similar over the two, five and seven-year periods

at average of 0.86. Therefore in examining the quality of the

Sukuk index performance while considering both return and

risk, we find that its superior performance is further enhanced

with lower volatility and a higher Sharpe Ratio.

Table 3: Sharpe ratios of DJSI and WBIG

Sharpe Ratio

2-year 5-year 7-year

Dow Jones Sukuk Index 2.96 0.47 0.53

World Broad Investment Grade 0.87 0.87 0.85

(WBIG) Bond Index

Source: Bloomberg and CIMB-Principal Islamic Asset Management as

at end-September 2012

Sukuk investing offers an enlarged investment universe

Unlike Shariah compliant equity investing, which is a subset of

global equity, Sukuk is a unique investment space that enlarges

the existing conventional fixed income investment universe

to grant conservative investors attractive opportunities in a

completely separate class of fixed income assets.

The number of constituents in the DJSI has tripled in two

years, largely due to active participation by governments and

corporations that have facilitated numerous Sukuk offerings.

The number of constituents in DJSI has increased from 13

(in June 2010) to 36 (as at the end of September 2012) 4 . In

addition, the constituents of the DJSI have similar ratings to

those of the WBIG. Both indices require a minimum quality of

‘BBB-‘ or ‘Baa3’ by the rating agencies 5 .

Moving forward, we anticipate that more issuers will participate

in the Sukuk market. Today Sukuk investors are seeing several

first time issuers come to issue in their market. For instance,

the Republic of Turkey issued a US$750 million benchmark

issuance in September with Citigroup and HSBC included as

bookrunners. Further, following on the sovereign issuance,

Turkey’s Sukuk market is gathering even more momentum as

companies from the national airline to the biggest telephone

operator plan Sukuk offerings 6 .

Sukuk investing offers strong international


The performance of the DJSI has remained resilient despite

political unrest in pockets of the Middle East. The stability of

the index is a reflection of the geographical diversification it

offers. The sovereign representation of Sukuk issuers in the

DJSI leads with Malaysia, and is followed by Saudi Arabia,

Qatar and Indonesia.

Table 4: Percentages of sovereign debt in Dow Jones Sukuk Index



Malaysia 17.08%

Saudi Arabia 16.21%

Qatar 13.60%

Indonesia 6.04%

Dubai 5.53%

Abu Dhabi 3.60%

Total 62.06%

Source: Bloomberg and CIMB-Principal Islamic Asset Management

In addition to the benefits of diversification, these jurisdictions

have strong macroeconomic fundamentals and offer exposure

to oil and gas-related revenue streams which offer deep

reserves support to issuers. In addition, more than 60% of the

investment universe of DJSI is comprised of investment grade

Sukuk from countries which may not register significantly, if at

all, inside the conventional index.

Sukuk investing offers Shariah compliant exposure to


Investment exposure to the financial sector is considered a

proxy for the growth of an economy since banking prospers

with an economic expansion.

However the Shariah compliant equity portfolio will typically

filter out the financial sector, as they tend to be conventional

banking and financial services entities. Shariah-sensitive

investors who want exposure to the financial sector can still

access the sector through the Sukuk asset class. Below are

the sector weightings of both indices:

November 2012 19


Table 5: WBIG and DJSI Sector Weightings


Dow Jones

Sukuk Index

Weightings (%)

World Broad Investment

Grade (WBIG) Bond Index

Government and 53.47 68



Financials 29.42 5.33

Utilities 6.30 2.31

Industrial 5.53 6.35

Energy 5.28 1.00

Collaterised (MBS 0 17

and Covered Bonds)

Source: Bloomberg and CIMB-Principal Islamic Asset Management as

at end-September 2012

As shown in table 5, financials constitute the second-largest

sector of about 30% in the DJSI. This is also an investment

opportunity for conventional investors who want to diversify

the quality of their overall portfolio’s exposure to the financial

sector as they can gain exposure to Islamic banks such as QIB

Sukuk Funding (Qatar), IDB Trust SVCS (Saudi Arabia) and

Abu Dhabi Islamic Bank (UAE).

Case study: Sukuk investing as a diversification


The benefits of diversification with Sukuk securities is not

just theoretical, it is demonstrable. For example, one can

examine the results of the following two scenarios to determine

if investing in Sukuk serves as a good diversification strategy

without compromising investment returns:

1. One portfolio which tracks the conventional index completely,


2. A second portfolio which is split, whereby 20% tracks the

DJSI and 80% tracks the conventional index

For the two-year period ending the 28 th September 2012, the

annualized returns of the second portfolio resulted in a slight

enhanced return of 4.88%, versus 4.52% in the first portfolio.

In addition, the second portfolio’s Sharpe Ratio was increased

significantly to 1.14 versus 0.87.

Table 6: Two-year returns and Sharpe ratios improved with

20% Sukuk allocation

Portfolio 1:

100% tracking the World Broad

Investment Grade Bond Index

Portfolio 2:

20% tracking the Dow Jones

Sukuk Index and 80% tracking

the World Broad Investment Grade

Bond Index





4.52% 0.87

4.88% 1.14

Source: Bloomberg and CIMB-Principal Islamic Asset Management as

at end-September 2012

Given low yield markets worldwide, a 36 basis points differential

in and of itself is not an insignificant improvement. Equally as

important, the improvement in the Sharpe Ratio shows that the

strategy can generate alpha or additional returns that better

compensate for risk.


As one can see, investment exposure to Sukuk can offer

diversification benefits. In addition, prices of Sukuk generally

hold up well by virtue that they are often treated as a ‘buy and

hold’ investment. This grants an additional layer of insulation

against volatility relative to conventional fixed incomes. With

additional information and enhanced knowledge, investors

are becoming more comfortable with Sukuk investing. One of

the most convenient and easiest ways to access the Sukuk

asset class is via a fund which invests in diversified portfolio

of global investment grade Sukuk such as the Al Hilal Global

Sukuk Fund. Launched in early 2012, the Al Hilal Global Sukuk

Fund has delivered a strong performance of 4.3% in only six

months since its March debut. The fund invests in a diversified

portfolio of Shariah compliant Sukuk issued by sovereign,

quasi-sovereign and corporations and aims to generate regular

income as well as capital appreciation.

There are clear signs that the Sukuk market is maturing and

spurring a growing interest in gaining investment exposure to

the asset class. Over the two-year period, we found similar

investment results with lower volatility compared to the

conventional fixed incomes. These similar investment results

also showed a clear improvement in the Sharpe Ratio over

the conventional index. Closer examination of the Sukuk

investment space revealed further diversification benefits for

investors who have until now only invested in the traditional fixed

income space. From its ability to enlarge the total fixed income

investment universe to offering international diversification with

credit quality and Shariah compliant financial sector exposure,

there is evidence which shows that diversifying a portion of

one’s overall investment portfolio to Sukuk investments away

from traditional fixed income will show an improvement in the


Sharpe Ratio without diminishing investment returns.



Source: Dubai World Seeks to Delay Debt Payments as Default Risk



Source: After Crisis, Dubai Keeps Building, but Soberly from the NY

Times on the 29 th September 2010


Source: Middle East Credit Compendium 2012 by Standard Chartered

Bank dated 2 nd May 2012


& 5 Source: Bloomberg


Source: Sukuk Taking Flight as Airline Readies Debut Sale: Turkey

Credit by Bloomberg dated 3 rd October 2012

CIMB-Principal Islamic Asset Management

Level 5, Menara Milenium, 8, Jalan Damanlela,

Bukit Damansara

50490 Kuala Lumpur, Malaysia

20 November 2012

chapter Profile

CIMB-Principal Islamic Asset Management (CIMB-Principal Islamic) is a dedicated Islamic global institutional asset management house,

combining the strength of 2 credible shareholders. The joint venture between CIMB Group and Principal Global Investors allows CIMB-

Principal Islamic to leverage on the compelling global Islamic credentials of CIMB Group (via CIMB Islamic) while Principal Global

Investor’s lends its expertise in global asset management.

CIMB-Principal Islamic won Best Overall Islamic Asset Management Provider of the Year 2012, Best Islamic Asset Management Company

in Asia, and Best Institutional Solutions Provider of the Year 2012 by Islamic Finance News Awards - Islamic Investor Poll 2012. At the

International Takaful Awards 2012 (London), the company was awarded The Best Asset Management House in Asia for the third year in

a row and also earned the Islamic Asset Management House of the Year by The Asset’s Triple A Islamic Finance Awards 2012.

Headquartered in Kuala Lumpur, Malaysia, the firm is strategically located in the world’s first country with a complete Islamic financial

system operating in parallel to the conventional banking system. This allows the firm to leverage on Malaysia’s comprehensive Islamic

financial infrastructure and its adopted global regulatory, legal and Shariah best practices.

Ramlie Kamsari

Deputy Chief Executive

CIMB-Principal Islamic Asset Management


Ramlie Kamsari is the deputy chief executive of CIMB-Principal

Islamic Asset Management (CIMB-Principal Islamic). As the head

of global sales & marketing, he also drives and oversees the global

institutional sales of CIMB-Principal Islamic’s full range of Islamic

funds to institutional investors in Europe, Middle East and Asia.

His responsibilities include implementing successful sales efforts

which targets relevant institutions and third parties, as well as

identifying new business opportunities and driving transactions

through to the close.

Since joining CIMB Group in 2004, he has held several senior

positions, including CEO and head, institutional sales of CIMB

Futures and CEO and director of CIMB Insurance Brokers. He

was also director and head, Islamic equity markets & derivatives of

CIMB Investment Bank.

Ramlie has extensive experience in the global financial industry,

spanning over 18 years across major financial markets and

covering the areas of global sales, advisory services and deal

executions of capital market products, derivatives products, risk

transfer solutions, and most recently, Shariah investment products.

In Singapore, his previous stints include Barings Futures, Daiwa

Co. and Refco Investment Services. Prior to joining CIMB Group,

he was vice president and head of global services at FIMAT, the

global derivatives trading division of Societe Generale. He holds a

Bachelor of Commerce from the University of Western Sydney and

a Graduate Diploma in Financial Management from the Singapore

Institute of Management.

Michael S. Zorich, CFA

Chief Investment Officer

CIMB-Principal Islamic Asset Management


Michael Zorich is the chief investment officer of CIMB-Principal

Islamic Asset Management (CIMB-Principal Islamic). He is

responsible for establishing and implementing investment

strategies for the firm’s clients and overseeing the performance of

both global Islamic equity and global sukuk portfolios.

A seasoned fixed income professional with a strong credit

background, Zorich has worked in tandem with portfolio managers

in the management of multi-sector portfolios. Previously, he was

managing director, special assets, for Principal Global Investors

(PGI) Fixed Income.

As the head of special assets group, he was responsible for

negotiations with distressed companies and the oversight of the

analysis, valuation and restructuring of all distressed debt in PGI’s

fixed income portfolios. Zorich joined PGI in 2001. Prior to that, he

was a senior associate at PrimeSolutions Capital Corporation.

Zorich is a Chartered Financial Analyst (CFA) and a member of the

CFA Institute. He obtained his Masters in Business Administration

(MBA) from Carnegie Mellon University and his Juris Doctor (JD)

from the University of Pittsburgh, School of Law. He is a member

of the Pennsylvania Bar and has a Bachelor’s Degree in Business

and Communications from the University of Pittsburgh.

Ramlie Kamsari,

Deputy Chief Executive

Tel: +603 2084 2289


CIMB-Principal Islamic Asset Management

Level 5, Menara Milenium, 8, Jalan Damanlela,

Bukit Damansara

50490 Kuala Lumpur, Malaysia

November 2012 21


Dispute Resolution: The Final Piece

of the Puzzle

With an eye on the growing complexity and internationalization of the

Islamic finance market, The Kuala Lumpur Regional Arbitration Center

(KLRCA) has become the first organization in the world to launch

its i-Arbitration Rules; a dispute resolution mechanism specifically

formulated for Shariah compliant transactions. Islamic Finance news

speaks to Sundra Rajoo, director of the KLRCA on this cutting-edge

idea and its role in pushing the industry to new heights.

The Islamic finance industry is fast attaining a globalized status;

taking a more international approach in the structuring of

products and contracts, and through the proliferation of crossborder

transactions amongst issuers and investors. Although

Malaysia is considered to be one of the most sophisticated

jurisdictions in terms of regulations and resolving contractual

disputes for Shariah compliant transactions, based on Bank

Negara Malaysia’ Shariah Advisory Council’s rules established

by the Central Bank Act 2009 and the Shariah council

established by the Securities Commission under the Securities

Commission Act 1993, the country’s dispute resolution

capabilities can still be considered insular, as the judgment of

the courts are only enforceable in Malaysia.

Although the practice of alternative dispute resolutions for

Islamic finance contracts are becoming more common in civil

and common law courts, the system is far from impervious to

further dispute. Issues with ambiguity concerning the language

used in the contract, and in some cases the constitutional

limitations imposed on judges to interpret laws derived from

religious sources have all become prevalent issues in the legal

decision making process.

22 November 2012


In a bid to create an effective and internationally enforceable set

of rules for Islamic commercial transactions, and to increase the

fluidity of cross-border transactions, the KLRCA’s i-Arbitration

rules were launched as a set of procedural rules which cover

all aspects of the arbitration process, allowing for the resolution

of disputes from any contract or agreement containing Shariah


The rules, which are the first in the world to adopt the United

Nations Commission on International Trade Law (UNCITRAL)

Arbitration Rules, ensures international recognition, while

taking into account Shariah principles. Essentially, it is the

first set of arbitration rules that cater to both conventional and

Shariah compliant transactions and contracts.

The rules are also based on the 1958 United Nations

Convention on the Recognition and Enforcement of Arbitral

Awards, or the New York convention – the defining element

within the i-Arbitration rules, according to Sundra. “The New

York convention is a convention in which countries enter into

and they agree to enforce foreign arbitral awards. This makes

arbitration different from litigation, where the foreign court ruling

of one country cannot be enforced in another country. It is so far

the most successful convention in the history of mankind, and

on the last count, involved 146 participating nations. Basically,

if you are a serious business nation, you are already part of

it. Our main challenge in structuring the rules was how to

make it compliant with the New York convention to ensure its

enforceability on a global level.”

“The most elegant ideas are usually the most simple,” Sundra

revealed; referring to the additional component- Rule 8, which is

activated in the event of a dispute involving a Shariah compliant

transaction. “The approach that the center has taken is that we

have to provide an avenue when an item of such significance

comes along, and see how it will be resolved in the arbitration.

Rule 8 comes into effect when there is a Shariah dispute. The

Shariah component is submitted to a Shariah Advisory Council

or expert for an opinion, and when the opinion comes back, it

is applied. For example, in a dispute involving Islamic financial

instruments, parties and the arbitral tribunal may agree to refer

the matter to Bank Negara Malaysia’s Shariah Advisory Council

or the Malaysian Securities Commission’s Capital Markets Actwhichever

is deemed relevant. In the instance of a situation

involving a Shii’te dispute for example, the parties and the

tribunal can appoint their own Shariah expert, as provided in

the UNCITRAL Rule, under article 26. Therefore, parties will

always be able to choose which Islamic school of thought

(madhab) to apply to their dispute. ”

Long-term view

It is the internationalization of the Islamic finance market which

spurred Sundra and his team at the KLRCA to formulate a

dispute resolution mechanism based on international laws and

acceptability before incorporating the Shariah element. “It is a

cutting-edge product. It took us two years to come up with this,

to deal with expert opinion and how it all ties together. A lot of

people will start with Shariah as a base, but we decided to work

from the New York convention and then incorporate the Shariah


“These rules can be used even when there is no Shariah

component involved. Rule 8 only gets activated when a Shariah

component comes into play. In Item 6 of Rule 8, it states that

the ruling of the relevant council or the Shariah expert may

only relate to the issue or question so submitted by the arbitral

tribunal; and the relevant council or Shariah expert shall not

have any jurisdiction in making discovery of facts or applying

the ruling or formulating the decision relating to any fact of

the matter which is solely for the arbitral tribunal to decide.

Therefore, they (the Shariah council) can only decide on the

Shariah component. It is the arbitral tribunal, not the Shariah

Advisory Council or expert, who is the final determinant on

the matter as the tribunal cannot delegate its powers to make

decisions.” he added.

“In the recent International Bar Association (IBA) Conference

in Dublin, the question of how people are dealing with Shariah

issues was raised, and to be honest, there is no experience

outside of Malaysia except in limited pockets such as Dubai

and Bahrain. The Malaysian system is so far the most

comprehensive,” Sundra explained.

Sundra believes that the best way to resolve disputes,

particularly from a business point of view is through arbitration:

“From my understanding, what is not forbidden is allowed in

Shariah. Most of these Shariah compliant products are the

ones that are allowed and not forbidden. And when you have

those products, you are marketing to the world at large and

therefore, there needs to be a dispute resolution mechanism

because people will have disagreements. And for business

people, resolution of those disagreements or disputes is best

done through arbitration.”

“For the first time, there is a viable dispute resolution mechanism

for Shariah-compliant products. The Islamic world has not

really explored international commercial arbitration, and after

a certain point, there is a dichotomy between a religious and

secular dispute system. In all honesty, business people do

not want to go to the Shariah court, and prefer a legal secular

system. A great deal of thought and care would have gone

into putting together the complex and sophisticated Shariahcompliant

deals and products, but if a business dispute arose,

they would have to go to conventional arbitration. With the

KLRCA i-Arbitration Rules, there is now an option for a dispute

resolution mechanism that is Shariah-compliant, thereby

putting the last block in place for a complete Shariah compliant


transaction,” he concluded.

Sundra Rajoo


Kuala Lumpur Regional Centre for Arbitration

No.12, Jalan Conlay, 50450 Kuala Lumpur

Tel: +603 2142 0103



November 2012 23


The Islamic Fund Management

Industry – Back to Basics

The Islamic fund management sector is still grappling with fundamental

challenges that could prove to be crippling to this nascent industry.


Although there are no current definitive figures, the size of

global Islamic assets is estimated at around US$1.2 trillion,

and is expected to grow at a rate of 10-15% in the next three

years, according to industry forecasts. Despite standing at only

0.5% of conventional assets, Islamic assets are still looking

to be managed and marketed effectively in order to mobilize

the sector and to create an efficient global Islamic fund

management industry. According to the 2011 Ernst & Young

report on Islamic Funds and Investments, Islamic funds’ assets

under management grew by 7.6% from 2010 to US$58 billion

in 2011; with Sukuk, commodities and capital protected funds

featuring as the investment modes of choice for the Islamic


However, it is hard to ignore the gap between total Islamic assets

and total assets under management, particularly in high growth

areas such as Asia and the Middle East. According to Raja Teh

Maimunah, the managing director at Hong Leong Islamic Bank,

Malaysia and Saudi Arabia still remain the top jurisdictions

for the Islamic fund management industry, particularly due to

regulatory efforts in providing screening services, especially

in Malaysia. “Only Malaysia has a list of screened equities -

and apart from Malaysia and Saudi Arabia, the Islamic fund

management industry is still small and insignificant,” she said.

“There are Shariah compliant equities in the Middle East which

you simply do not have access to. And it becomes expensive

to buy equities outside of Malaysia. From my experience in the

Middle East, we had to hire experts to screen the stock; thus

adding to the cost of the fund by 25 to 50 basis points (bps).

We had to hire screening consultants to seek equities for us

to invest in. Additionally, the channels for asset management

are still difficult to access outside of equities. In the fixed

income arena for example, the Sukuk market is still very much

concentrated in Malaysia. Apart from the ringgit market, there

is some activity in the MENA region. Investors are currently

focused on equities and fixed-income products, whilst most of

them post-crisis have moved to cash,” said Raja Teh.

A recent comparison done between the asset allocation for the

November 2012 25


Investment preferences amongst conventional and Islamic



assets 5%

Emerging market

bonds 20%

Global bonds 15%

Emerging market

equities 25%

Global equities 35%

conventional and Islamic markets by AmIslamic showed an

almost identical breakdown in terms of investment preferences

amongst conventional and Islamic investors - 25% in emerging

market equities, 35% in global equities, 15% in global bonds,

20% in emerging market bonds, and 5% in alternative assets.

The difference between the Islamic and conventional market lies

in the need for investments in Shariah compliant alternatives,

and the Islamic fund management industry will continue to

struggle as long as there is a lack of Shariah compliant solutions

in the market.

In the equities space for instance, the report by AmIslamic said:

“It is not possible to have an Islamic version available for every

conventional (non Islamic) investment product/ strategy out

there. For example, a typical equity asset allocation includes

an allocation to Smart Beta and when it comes to the Islamic

space, there are almost no Islamic Smart Beta funds available.”

On the fixed income side, the report commented: “A global

Sukuk fund will have significant exposure to emerging markets

and minimal exposure to developed markets as there are hardly

any Sukuk issues from developed markets. Therefore, it is not

possible to get a global Bond fund’s geographical allocation

with a global Sukuk fund. One of the solutions is to seek other

alternatives that replicate the payoff of a Sukuk (periodic

return and lower risk). We have developed an equity-based

solution that exhibits lower volatility and yields periodic income

(high dividend) to replicate the payoff profile of a Sukuk fund.

This solution supplements the allocation to global Sukuk and

addresses the geographical coverage/diversification issue.”

Monem Salam, the president of Saturna Capital, highlighted

the challenges currently facing the Islamic asset management

industry: including limited opportunities in the cross-border

space, higher fees and lack of competitiveness with the

conventional markets: “Most Islamic funds are currently

domiciled in Malaysia, and there is very limited opportunity for

cross-border distribution of funds. The Malaysian Securities

Commission is working hard to facilitate this with Dubai and

Hong Kong, but there are many other markets fund managers

are interested in. The opening up of other markets has to be

done on a regulatory level. Second, fees tend to be much

higher across the board in Asia compared to those in the west;

particularly the US and Europe. If you can access an Asian fund

in Europe which you can buy at less than a 1% expense ratio,

then why would you come to Asia to buy the same product at

1.5 – 2%? We have to be competitive on a global level in terms

of fees. Although the cost of running funds is a lot cheaper in

Asia, expenses are lower in US and Europe.”

In terms of Islamic exchange-traded funds, education still

remains a key issue, says Mahazir Othman, CEO at i-VCAP.

“The Islamic ETF market is still underdeveloped, and

education is still a main concern. There also needs to be

more understanding on how investors actually use Islamic

ETFs in their portfolio to enable them to meet their investment

objectives. The current mentality in Asia is: ‘Why do we need

to go beta when we can do our own stock-picking?’ and most

Asian investors are stock-pickers. Another challenge is product

depth. There are currently not enough Islamic ETFs in the

market for investors to asset allocate their portfolios using this

instrument. It is important to get managers to roll out more

products to address this challenge.”

There are Shariah compliant

equities in the Middle East

which you simply do not

have access to

The ongoing debate on the use of derivatives to hedge risk in

the Islamic finance space has also brought about challenges

in the Islamic fund management industry; with the divide

between the proponents of derivatives and those who disagree

becoming more apparent. From a fund manager’s perspective,

Monem believes that it is possible to avoid the use of derivatives

all together, simply by picking the best stocks to invest in. “It

depends on the mandate of the portfolio. When we look at the

fundamentals of derivatives and their purpose, it is essentially

to transfer the risk from you to someone else. Islamic finance is

about sharing risk, whilst derivatives are about transferring risk.

In Islamic finance, the gains and losses are shared.

“The way you can fundamentally do that is by going back to

the fundamentals of investments – i.e. plain vanilla structures.

We have managed to provide our clients with high returns and

low volatility investment products without derivatives, simply by

buying companies that pay you back in dividends so you can

utilize the gains in your portfolio, and by holding cash if you

don’t like a certain investment. If you stick to the fundamentals,

you will realise that the use of derivatives simply add cost to

your portfolio and lower your returns - and that doesn’t really

help. In the conventional space for instance, normal indexes

actually outperform hedge fund indexes, so what is the point of

doing that (derivatives) except for someone lining their pockets

with money?” he added.

It is absolutely vital for the Islamic industry to develop effective

products with competitive returns to enable the efficient

management of Islamic liquidity, in order to create a robust

investment environment and attract more investors to ensure


the health and sustainability of the Islamic capital markets.


November 2012


Diverging Models Shape The

Growth Prospects For Takaful

The growing need for insurance that complies with Shariah law

means that the global Takaful sector is becoming an increasingly

significant niche within the wider insurance industry. In the following

Q&A, Standard & Poor’s Ratings Services (S&P) compares the Takaful

markets in the Middle East and Asia, and discusses the outlook for the

sector amid the global economic slowdown.

What’s fueling the growth of Takaful globally?

Global Takaful growth was about 20% in 2011, although actual

rates varied widely between regions. Sharp spikes in growth

in countries such as Saudi Arabia were triggered by regulatory

action to expand compulsory insurance covers, particularly

medical insurance. For Asia, the family sector was boosted by

the customers’ needs and growth of agents and bank channels


Is such growth sustainable?

We expect to see generally strong growth over

the long-term, however, we don’t anticipate

that the sector will sustain 20% growth over

the next few years, given the stuttering global

economy and the relative maturity of some

of the larger Takaful markets. Nevertheless,

Takaful has developed most fully in countries

that have relatively high economic growth

rates, and where the state follows Islamic

principles. Economic growth can support

greater personal wealth, leading to an

increase in insurable asset risk. In addition,

if sufficient wealth is created, we expect the

longer-term family (life) insurance sector will

also expand, especially in the GCC region.


How does the Takaful market in Asia

compare to that in the Middle East?

Takaful has developed most in the Gulf Cooperation Council

(GCC) region and Southeast Asia, but individual countries in

each region have taken different routes to develop the sector.

Malaysia is the most well-established Takaful market, which is

reflected in its size and relative sophistication. It contributes

over 17% to global contributions and has grown five-fold over

the past decade. In Malaysia’s Takaful market, family business

was about 63% of total contributions - the remainder comprised

general business. Most family business is linked to mortgage

lending (about 47% of total family contributions in 2011),

which perhaps reflects linkages between Takaful companies

and banks. For general business, mirroring the conventional

market, motor is the dominant business line, accounting for

55% of total general contributions in 2011.

The market in Saudi Arabia is larger but less seasoned. All

insurers have to operate to a cooperative model broadly

comparable with the various Takaful models used elsewhere.

While the country has seen very high growth recently, the main

source of growth over the past five years has been regulatory

action to introduce compulsory medical and motor insurance.

As a result, over 50% of global Takaful sector contributions

derive from Saudi Arabia. We do not expect the industry to

maintain the growth levels it saw after these changes, but it

is likely to remain high relative to global levels.

Is the investment approach similar between

Asian and Middle East Takaful companies?

A fundamental requirement of Takaful companies

is to provide a fully Shariah compliant service

to both fund members (policyholders) and

investors. Southeast Asia makes greater use of

Sukuk for Islamic finance than the GCC region.

Its more developed market provides meaningful

volumes for the Takaful sector to invest in. In

Malaysia, more than half of Takaful insurers’

portfolios are invested in Sukuk, with the

remainder invested in cash & equivalent,

equities and other assets.

In contrast, a shortage of Shariah compliant

rated instruments in the GCC region means that Takaful

companies tend to invest in equities and real estate at a higher

portfolio than in Malaysia. Such investments can carry high

levels of value volatility and illiquidity and can drag on Takaful

companies’ balance sheets. However, the Sukuk portfolio for

GCC Takaful operators is increasing, reflecting the increase in

Sukuk issuance in recent years.

Many Takaful companies, particularly in the GCC region,

were set up during the boom years of the early 2000s. The

historically high investment valuations that operated when

they purchased their assets subsequently resulted in realized

losses. The current low investment yields strain bottom-line

results further. In our analysis, we consider the limited range of

acceptable instruments in which Takaful companies can invest

November 2012 27


of the companies involved will sustain their profitability over

the longer term, particularly in the GCC region. However,

developments in Malaysia - the largest Takaful market in

Southeast Asia - appear much more healthy and sustainable.

They are supported by more sophisticated regulatory oversight

and the stronger investment profile of the industry.

How is the global economic slowdown affecting the growth

of Takaful?

The worldwide slowdown in economic activity will ultimately

depress growth in economies that provide resources for

manufacturing; this happens to include many of the resourcerich

countries where Takaful is developing. For insurers, this

constrains growth, partly by reducing demand for insurance,

but also by limiting investment yields.

Globally, the current low investment yields have hurt insurance

providers and markets. Insurance, Takaful included, is an

asset-rich business. Fierce competition in the economies

where Takaful is developing is putting underwriting margins

under pressure, especially in the high-volume, low-margin

retail lines that form the bulk of Takaful business. Meanwhile,

yields on Shariah compliant instruments and investments

are increasingly depressed. Providers will therefore need to

maintain their underwriting profitability to succeed.

to be a constraint that places downward pressure on their riskbased

capital position.

Is there potential for cross-border Takaful


To date, the primary Takaful sector in

Southeast Asia and the GCC region has

tended to comprise local operators that rarely

engage in cross-border activity. This reflects

the relatively small operational scale of the

sector and its still-developing status.

However re-Takaful companies, which

provide protection to the primary Takaful

sector, are operating in increasingly diverse

geographical areas. We see Southeast

Asian-based re-Takaful companies Willis

competing and working with GCC-based re-

Takaful companies to develop and service

the growing capacity needs of the primary

sector in Africa, Southeast Asia, and the GCC region. As local

companies become increasingly mature and financially robust,

we expect cross-border activity in the primary sector to grow.

We also expect to see some consolidation in the more overpopulated

insurance markets.

What is S&P’s key concern for the Takaful market?

We remain concerned by widespread use of high-risk

investment strategies by Takaful providers, and by the sector’s

lack of global standards in areas such as accounting standards

and Shariah compliance. In our view, it is unclear how many

What are the growth prospects of Takaful versus

conventional insurance?

Over the next 12-18 months, S&P expects Takaful company

contributions in the GCC region to significantly outgrow

premiums in the local conventional insurance industry, as

well as the global insurance industry. Global

insurance premium growth is expected to be

little more than 2% in 2012; by contrast, in its

World Takaful Report, Ernst & Young estimates

that gross Takaful contribution for 2012 will grow

to US$12 billion, a year-on-year increase of


In Southeast Asia, we anticipate that tightening

regulatory requirements in Malaysia could

depress the strong growth momentum the

industry has built up over the short-to-medium

term. That said, tighter solvency calculations

are likely to strengthen the financial profiles of

Takaful operators and operators will also benefit

from revised risk management practices in the


long term.

Connie Wong,

Managing Director and Analytical Manager for Insurance Ratings,

Asia-Pacific, Standard & Poor’s

Kevin Willis,

Director, Insurance Ratings, Standard & Poor’s

28 November 2012

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