Plenary Session Four: ISLAMIC BANKING AND FINANCE

aba.org.tw

Plenary Session Four: ISLAMIC BANKING AND FINANCE

Islamic Finance- Market Update

Arul Kandasamy

Head of Islamic Financing Solutions

Barclays Capital

ABA 24th General Meeting

1-2 November 2007, Hong Kong


Why Islamic Finance?

• Post Sept 11 repatriation of funds and high oil prices have led to a revival

of Islamic finance

• New and alternative source of funding

Between $300bn to $1,000bn of ‘Islamic’ funds available for investment

• Provides clients/investors with a solution that accords with their beliefs

Initial interest was in predominantly Muslim countries e.g. Malaysia, Bahrain,

UAE

Today, Islamic banks and finance houses are found in the UK (Islamic Bank of

Britain) and in the US (Lariba)

• Public relations benefit

Particularly when doing business in Islamic countries

2


The sukuk market continues to grow…

Exponential

Exponential

growth

growth

since

since

2002

2002

Investor

Investor

sophistication

sophistication

and

and

demand

demand

is

is

growing

growing

Issuance volume (US$ eq bn)

24

20

16

12

8

4

0

• Recent trends in the Middle East have encouraged development of the sukuk

market

Corporate expansion, both organic and M&A

Increased rated sukuk issuance

International sukuk supply

+31%

+120%

2002 2003 2004 2005 2006 2007 YTD

Source: Bloomberg, Global sukuk Issuance 26 October, 2007

Perceived reduction in geopolitical risk for the GCC region

• Increased investor demand has led to significant oversubscription and price tension

Estimated US$ 250-300bn of Islamic funds available for investment

Conventional funds now form the bulk of benchmark size sukuk investors

More international banks active in sukuk issuance

3


Sukuk issuance by Country

Sukuk Issuance (2007 YTD)

Sukuk Issuance (2006 FY)

3,500.00

3,000.00

4,000.00

3,500.00

2,500.00

2,000.00

1,500.00

1,000.00

500.00

0.00

CIMB

HSBC

Barclays Capital

Citi

Deutsche Bank

Standard Chartered

NBAD

Credit Suisse

BNP Paribas

Goldman Sachs

Malaysia

Saudi Arabia

Kuwait

Qatar

UAE

Bahrain

3,000.00

2,500.00

2,000.00

1,500.00

1,000.00

500.00

0.00

Dubai Islamic

Bank

Barclays

Capital

CIMB

HSBC

AmInvestment

Bank

Asseambankers

RHB

Investment

Deutsche Bank

Standard

Chartered

United

Overseas Bank

Malaysia

Saudi Arabia

Kuwait

Qatar

UAE

Bahrain

• 2006 issuance was dominated by UAE and Malaysia

• 2007 has seen more diversified issuance, particularly from Saudi

Arabia, Kuwait and Qatar

• Turkey, Pakistan, India and Indonesia are likely to be new markets in

2008 given rumours of deals in pipe

4


Sukuk issuance by Currency

Sukuk Issuance Currencies (2007 YTD)

SAR

12%

Sukuk Issuance Currencies (2006 FY)

SAR

5%

MYR

30%

USD

58%

MYR

39%

USD

56%

• MYR likely to dominate full year 2007 issuance due to

upcoming mega sukuk in Malaysia (Maxis)

• SAR growth likely to continue as more Saudi businesses tap

the sukuk market

5


Sukuk structures

• The table below shows the three most common Islamic structures used for Sukuk

• When properly structured, there is no economic / pricing impact from any one structure

over another

• The difference for the issuer lies in the degree of flexibility allowed for use of proceeds and

requirement for asset contribution

Ijara Musharakah Mudarabah

Pros

• All funds raised through the sukuk

issuance can be freely utilised

• No need to account for returns or

use of funds

• Borrower would not face any

restriction on the use of proceeds,

for an amount equal to the value of

the assets being contributed to the

Musharaka.

• No need for asset contribution

Cons

• Need for asset contribution equal

to the value of Sukuk being raised

• Assets are effectively encumbered

for the duration of the Sukuk issue

• Any proceeds above that amount

would have to be applied per the

Investment Plan to generate periodic

returns to Sukuk holders

• Need for asset contribution by

borrower, but less than an Ijara

• Funds of the Mudarabah must be

applied per the investment plan

• Need to account for returns and use

of funds

6


Historically, sukuk have been issued using Ijara (sukuk

1G) and Musharaka (sukuk 2G) structures…..

Issuer Date Structure Size

Govt of Malaysia June 2002 Ijara US$600m

Govt of Qatar October 2003 Ijara US$700m

Dubai Global Sukuk Nov 2004 Ijara US$1,000m

Wings FZCO June 2005 Musharaka US$550m

PCFC Sukuk January 2006 Musharaka US$3,500m

QREIC September 2006 Musharaka US$270m

Nakheel Sukuk December 2006 Ijara US$3,520m

7


However, these structures had disadvantages…..

• In an Ijara (leasing) sukuk, there is a need to transfer title to underlying

assets equal to the sukuk value from the Obligor to the sukuk holders

• In a Musharaka (joint investment partnership) sukuk, there is a need for a

partial transfer of title to underlying assets from the Obligor to the sukuk

holders

• The transferred assets are encumbered for the duration of the sukuk

• In certain countries there may be adverse tax, accounting and legal

implications (e.g. capital gains tax, property transfer tax etc.)

• An obligor may not have assets of sufficient value relative to the amount of

sukuk being raised

8


This led to the Mudaraba sukuk (sukuk 3G)

being developed

Borrower as

“Mudarib”

Sukuk Investors

US$ [xx]

Periodic

Distributions

and Redemption

Amount

Periodic

1 US$ [xx]

2

SPV

“Issuer”

Distributions

Mudaraba

assets

Redemption

Amount

Borrower as

“Obligor”

3 Purchase Undertaking

Returns to sukuk holders

Mudaraba is is an an

investment partnership

between a manager

(mudarib) and and provider

of of funds (rab ul ul maal)

Sukuk proceeds are are

invested in in accordance

with a sharia compliant

Business Plan

Returns to sukuk holders

are are derived from

application of of the the

Mudaraba Assets

9


Mudaraba and Equity-linked sukuk

PCFC Aabar Nakheel Aldar IIG Dana Gas

Location Dubai Abu Dhabi Dubai Abu Dhabi Kuwait

Industry

Ports & Free

Zones

Investment

Oil & Gas Property Property Oil & Gas

Company

Size US$3.5bn US$750m US$3.52bn US$2.53bn US$200m US$1.0bn

Launched Jan 2006 June 2006 Dec 2006 Feb 2007 Apr 2007 Oct 2007

Structure Musharaka Mudaraba Ijara Mudaraba Mudaraba Mudaraba

Rated No No No No No No

Sharjah

• Globally the equity-linked market is used by corporates at all stages of development

(from pre-IPO to long established corporate) and size (from tens of millions to tens

of billions of dollars)

• Even at this early stage in its development the ME equity-linked sukuk market is

demonstrating the same strength and diversity

• Equity linked sukuk has spurred the growth of the sukuk market

10


Items for Consideration

Sharia

Capacity/Infra

•Arrangers

•Clients

Regulatory

• Licensing

Expertise

CHALLENGES

Willingness

Accounting

• Balance sheet

• P&L impact

• Normally ‘form over

substance’

Operations

• Paperwork/admin

• MIS

• Procedures

Tax

• Capital gains

• Taxing of

‘Profit/Rentals’

11


Legal Issues

• Why structure Islamically?

Investor base?

Belief

— Apart from real estate/private equity and a few project finance deals, most of the

large Islamic financings have had very limited participation from ‘pure’ Islamic

investors

— E.g. Islamic banks, some corporates: Al Shaya, Abdulatif Jameel

— Countries/sovereigns e.g. Malaysia, Pakistan, Bahrain, Qatar

— Government linked companies e.g. Khazanah, Nakheel, Telekom Malaysia

Marketing and Publicity

• Importance of maintaining Shari’a compliance

A Shari’a financing will expressly state in the relevant contracts that is it to be “construed

in light of the principles of the Shari’a” (or similar). It is important to note that if the

parties state that their intention in this way, the transaction must actually be Shari’a

compliant – if it is not there is a risk that transaction will be declared void.

12


Arul's Unscientific Take on Sharia Opinions

MODERN FINANCE

IS WRONG. ONLY

CLASSICAL

CONTRACTS ARE

ALLOWED

MODERN FINANCE IS

OK. USE SHARIA

BUILDING BLOCKS TO

REPLICATE

RISKS/REWARDS

IF MODERN FINANCE

IS OK, THEN WHY NOT

JUST USE

CONVENTIONAL

STRUCTURES??

Rigid

Liberal

13


How to Promote Innovation?

Reward

Innovation &

Collaboration

Document & Share

Best Practice

Processes, Support,

Infrastructure

Understand Client/ Investor Needs

Promote Culture of Innovation, Adapt to Sharia

Articulate and Regularly Reinforce Mission & Strategy

Outcome

• New ideas e.g. PCFC

US$3.5bn convertible

sukuk with ‘look back

option’

• Increased profitabilityfirst

mover advantage

• Opens new products and

markets e.g.

convertibles/

exchangeables

• Convergence with global

financial system

14


Issues for Consideration

• Lack of standardisation

— Of products and of documentation

— Good progress made by ISDA/IIFM

• Sharia Issues

— Need national/regional regulations to spur adoption given the stance taken by

sharia boards, particularly in the Middle East

• Accounting treatment

— On or off balance sheet? Form over substance?

— Balance sheet inflation?

• Tax, legal and regulatory treatment

• Complexity and unnecessary, particularly for corporates

15


Suggested Next Steps

• Greater interaction between product developers, sharia scholars,

regulatory authorities, accounting bodies and standard setters

• Increase client education and awareness of Islamic alternatives

• Increase expertise of practitioners/product developers to

develop creative solutions

• Explore the notion of using ‘most efficient solution’ even though

it may not be strictly sharia compliant

16


Questions

&

Answers

17

More magazines by this user
Similar magazines