Opportunities & Trends in Islamic Finance - Euromoney

The 2008 guide toOpportunities & Trendsin Islamic FinancePublished in conjunction with:Abu Dhabi Commercial BankBank AsyaBMB GroupFWU GroupLondon Stock ExchangeQatar Islamic BankSHAPE Financial CorporationTürkiye FinansUnicorn Investment BankJanuary 2008

ContentsIntroduction: 2Expanding the frontiers of Islamic financeBy Abdulkader ThomasParticipation banking: 4A growing sector in TurkeyBank AsyaLondon acts as global gateway for 6Islamic financeLondon Stock ExchangeIslamic capital markets: 8Still breaking recordsBy Philip MooreThe potential of Bancatakaful 14FWU GroupThis guide is for the use of professionals only. It states the position of themarket as at the time of going to press and is not a substitute for detailed localknowledge.Euromoney Institutional Investor PLCNestor HousePlayhouse YardLondon EC4V 5EXTelephone: +44 20 7779 8888Facsimile: +44 20 7779 8739 / 8345Directors: Padraic Fallon (chairman and editor-in-chief ), Sir Patrick Sergeant,The Viscount Rothermere, Richard Ensor (managing director), C.J. Sinclair, NeilOsborn, Dan Cohen, Christopher Brown, J P Williams, John Botts, Colin Jones,Simon Brady, Tom Lamont, Gary Mueller, Diane Alfano, Mike Carroll, ChristopherFordham, Jamie Gonzalez, Jane WilkinsonEditor: Sarah MinnsDirector of research guides: Mike CarrodusCover illustration: Garrett FallonPrinted in the United Kingdom by: St Ives, Roche, UK© Euromoney Institutional Investor PLC London 2007Euromoney is registered as a trademark in the United States and the UnitedKingdom.

Expanding the frontiers ofIslamic finance2007 was a year of achievement for Islamic finance, with growth on all fronts. Yet the sector stillfaces great challenges, not least in finding and training enough Islamic bankersThe Islamic finance industry has never enjoyed a year like 2007. Inevery market and every aspect, the providers of Islamic financial solutionshave surpassed their past achievements. They have grown thebalance sheets of Islamic banks by 40% in 2007; more than quadrupledthe issuance of new sukuk; expanded to new frontiers, and improvedevery aspect of their business in established markets.But the industry faces three great challenges if it is truly to expand itsfrontiers: are there sufficient qualified people; are Islamic and regionalbanks able to pick up the slack created by retreating global banks, andwill regulators implement the rules that allow a well-ordered businessto compete on a level playing field? Even if 2007 was a great year, thepromise will not be buoyed by high oil prices, rather by elbow grease.The Sukuk spaceSlowly, the Saudi Arabian market is awakening to the opportunity touse sukuk for corporate finance. Although the Capital Markets Authorityhas not yet issued sukuk rules, important corporates such as SABIC,Saudi Consolidated Electricity Company (SCECO), Dar Al Arkan and theSaad group have issued. More will follow. The large issuances of SABICand SCECO were placed domestically, demonstrating the capacity forfunding in the local market: an important omen for the future. GivenFigure 1: GCC vs Malaysia value of Sukuk issues, 2005-2007Total value of issues, $bln35302520151050GCCMalaysiaNumber of issues20052006 2007the comparison of population and GDP between Saudi Arabia and Malaysia,one can only imagine that the implementation of the right sukukrules in Saudi Arabia will turn that key market into the true secondpillar of sukuk activity alongside Malaysia.The sukuk market faces other important challenges, including thegauntlet thrown down by Muhammad Taqi Usmani at the Accountingand Auditing Organization for Islamic Financial Institutions (AAO-IFI) conference in November 2007. Not only Saudi Arabia, but otherimportant Islamic markets require the definition of rules that will allowefficient special purpose vehicles to be formed, with bankruptcy remoteness,and for the formalization of the Anglo-American concept of“true sale” under local law. These rules and other that enable the sukukmarket to its fullest only solve part of the problem. Usmani pointed outthat many sukuk are structured in a way that makes them more like aloan than an Islamic lease or partnership; and this takes them out ofAAOIFI compliance. As a result, the market faces the new question ofwhat qualifies as a true Islamic instrument, and whether that instrumentis easily traded outside of the explicitly defined Islamic space.Perhaps GCC and MENA regulators need to contemplate importing theMalaysian style of integrated Sharia’a oversight and regulation.Because the sukuk market is not yet efficient, despite its dynamicgrowth, the syndication market remains hot. Syndicated Islamic160140120100806040200Number of issuesSource: IFIS, 19 December 2007project finance is following the same degree ofexperimentation as the sukuk market. In the pastyear, large-scale declining balance partnerships,forward leases, salam (forward sales of commodities)and tawarruq (an adaptation of murabaha)deals have been syndicated in the project financeand corporate finance market. This is in addition tothe continuously active syndicated Islamic tradefinance market.Project demandThe Islamic project finance market’s opportunitiesare beyond imagination, whether they be inmaster-planned cities in almost every Middle Eastand North African country, modernization of thehydrocarbon sector on a global basis, or lateralinvestment by GCC countries into the downstreampetrochemicals and plastics business around theworld. And, increasingly, many of the businessleaders guiding these projects are seeking partialor complete financing on a Sharia’a-compliant basis.This demand is helping many Islamic investorsplace their funds, but it also requires the expertiseof traditional global and investment banks to

structure and manage the project risks and financing. With inflationarypressures and shortages of certain building materials as well asinsufficient engineers, 2008 may see a cooling in this sector. Worse, it isunclear how much the credit crisis in the West will cause the traditionalplayers in project finance to retrench and be less active at a time whenthe market is demanding their skills.New market opportunitiesThe two great developments of the past seven years include the improvementof economic standards in many Muslim countries as civil orderor economic growth have been restored, and the petroleum boom.Both realities are rapidly expanding the capabilities of Muslim savers inAfrica and Southeast and South Asia, as well as the MENA region. Theincreasingly sophisticated Muslim consumer is demanding comparableservices at a fair value from Islamic providers. The result has been theemergence of a robust takaful sector with both regional and globalplayers providing robust and innovative solutions.Takaful is the Islamic alternative to traditional insurance, and its growthis creating demand for new and better asset management solutions. Awide variety of new products and adaptations of new products is beingintroduced to the market. These range from efforts to execute betterwith plain vanilla products to highly debated structured products andderivatives that some are testing in the Islamic market. On the onefor Islamic bankers and investment bankers. The best way to characterizethe four qualifications now available is as a good start. But nothingyet blends a practical, multilingual approach to providing prospectiveand practising Islamic bankers with the correct balance of Sharia’aunderstanding and banking knowledge. Moreover, many are geared towardspeople with a certain, relatively high job functionality or highereducation. With the current growth of Islamic banking and finance,too many tasks from the back office to the CEO’s job are performed bytalented people whose understanding of Sharia’a ground rules is simplistic.The directors of the leading Islamic institutions need to elevatethe role of comprehensive assessment based training to the forefrontof their agendas.ConclusionWill the credit crunch deflate our hopes for 2008? The many achievementsof 2007 are built on a deep cooperation between the leadingglobal financial institutions from the West and the Islamic financialsector. If the global banks falter due to the credit crunch, one mustask whether Islamic banks and investment banks have the ability andthe capacity to pick up the slack. In the sukuk market, two importantevents are giving contradictory answers. Although the funding forSABIC I and SCECO was largely from Saudi Arabian investors, the organizationof the deals came from HSBC. This causes one to wonder if theGCC and MENA markets are ready. Important bankers say yes, but we“In every GCC market and Malaysia, every aspect of consumer and corporatefinancial services is addressed by an Islamic choice. This growth of alternativesis giving depth to the market and assuring its long-term stability”hand, the demand for better and more sophisticated investing is beingmet by more and more providers in the takaful and asset managementfields. On the other hand, the surplus of cash among Islamic investors iscausing experimentation that is challenging on every frontier.But the market is enjoying new developments of significance. Countrieslike Turkey and Egypt, formerly less at the frontier of Islamicfinance, are moving forward. Significant new investments by GCCIslamic investors into Turkey, Egypt, Pakistan, the UK and Indonesia arebringing life to these markets and creating new opportunities for thefuture of both the inbound monies and the investors themselves.Although some analysts believe that the volume of new Islamic banks,finance companies, investment banks and funds is unsustainable, thereality is that consumer choice is winning. But the real meaning is thatin every GCC market and Malaysia, every aspect of consumer and corporatefinancial services is addressed by an Islamic choice. This growthof alternatives is giving depth to the market and assuring its long-termstability.The people challengeNonetheless, there remains one great challenge. There are not enoughIslamic bankers to go around. And, there is no accepted qualificationhaven’t seen the market in action without the global banks. In contrast,the robust Malaysian sukuk market enjoys the participation of foreignbanks, but does not rely on them to lead or fund deals. Surely the talentand funds exist in the global Islamic market, and it can function withthe scaled down role of global banks. Indeed, the initiative, whether inPakistan, ASEAN countries or the MENA/GCC region to address takaful,asset management and consumer needs is almost completely homegrown - which leads to the as yet unfulfilled need for better and moreintegrated training.For further information, please contactAbdulkader ThomasPresident & CEOSHAPE Financial Corp.Vienna, Virginia & Kuwait CityEmail: info@shapefinancial.comINTRODUCTION • Expanding the frontiers of Islamic finance

Participation banking: Agrowing sector in TurkeySince its introduction in 1985, participation (interest free) banking has grown rapidly in Turkey, withlocal, Middle East and international institutions all introducing products to meet the demand. In its11-year history, Bank Asya has firmly established itself as one of the leaders in the fieldParticipation (interest free) banking was introduced to Turkey in 1985via the establishment of two finance houses, following the government’sspecial legislation on interest-free banking, issued in December1983. By the end of 1996, the establishment of Bank Asya took the totalof these finance houses to six.Similar to other Islamic banks around the world, participation banks inTurkey offer their customers profit-sharing proceeds instead of interestand charge borrowers participation-sharing instead of loan interest -hence the name participation bank. The holders of accounts share boththe profits and losses that result from investment of their funds. At theend of the investment activity, profits are shared between the banksand account holders, and the banks can get a maximum of 20% of theprofits. After deduction of the banks’ share from the accruing profits,the balance is paid to the holders prior to maturity.The participation banks offer their clients a full range of productsjust like commercial banks including collection services, credit anddebit cards and personal loans in retail banking; cash management,production support, POS and other electronic banking services inSME banking; general corporate finance, project finance in corporatebanking and finally trade finance, structured finance and internationalsyndications in international banking.Bank Asya: a key playerOne of the key players in the market is Bank Asya. Established on 10 October1996 as a Turkish private finance house, Bank Asya ranks amongthe top 15 banks in Turkey by asset size, with total assets reaching USD3.1 billion as of year-end 2006, and market share of approximately 1.2%of the total banking market in Turkey. The bank is the largest amongthe four participation banks in Turkey, with a 30% market share.Asya is subject to the Turkish Banking Act and the regulations of theBanking Regulation and Supervision Agency and Savings DepositInsurance Fund. The latter institution was established to, among otherthings, insure deposits and manage and/or liquidate distressed orinsolvent banks. Bank Asya was the first special finance house to beawarded the ISO 9001 Quality Management System Certificate.Participation banks are authorized by the Banking Act to collectdeposit funds from the public under the profit-and-loss participationaccounts and special current accounts. The profit-and-loss accountsare a version of the Islamic finance instrument, where the bank utilizesthe funds deposited by account holders as an accumulated poolfor specific business activities. Any profits or losses (typically 80%)are shared between the account holder and the bank, in an agreedproportion.In addition to participation banks, there are a growing number of institutionsfrom the Middle East that have a presence in Turkey, such asDubai Islamic Bank, ABC Islamic, and Amlak Finance. International financialinstitutions such as HSBC, BNP Paribas, Calyon, Citibank, ABN Amro,Citibank and Deutsche Bank also offer Islamic products alongside theirconventional offerings, highlighting the growing appetite for suchproducts among Turkish clients.The Turkish Participation Banks Association (TKBB) estimates thatassets held by participation banks, as an integral part of the Turkishbanking system, have grown by 740%, whereas loans have grown 800%since 2000. The Turkish participation banking sector, employing just under10,000 people and with over 400 branches throughout the country,has grown at a consistent rate of approximately 40% a year since 2001and at the end of 2006 and the Participation Banks constituted 3.25%of the banking system in terms of asset size, 5.4% in terms of lendingand 3.9% in terms of deposits. It is estimated that the assets of participationbanks in Turkey will exceed $25 billion, up from $8.5 billion, inthe next decade and will account for 10% of the whole banking system.As the leading participation bank in Turkey, Asya’s assets grew fromUSD 1.9 billion at the end of 2005 to USD 3.1 billion at the end of 2006.This continuous expansion is an indicator of the demand for interestfreefinancial products and services in Turkey.Bank Asya has been assigned long and short-term foreign currencyratings of B with a positive outlook by Fitch Ratings. Asya was the firstparticipation bank in Turkey to receive a rating from Fitch as part of itseffort for full transparency. Asya also holds a Ba1 rating from Moody’s.Bank Asya has been the fastest-growing indigenous bank since 2001,enjoying a return on equity employed of 31%, the highest in the sector.It operates with 120 branches situated across Turkey. The bank also hasjoint agreements with other Turkish Banks and serves the individualclient base through more than 4500 ATM machines. Asya serves morethan 1 million retail clients with Housing and Car loans, installment plans,credit and debit cards and insurance services. Currently the bank has700,000 credit card holders with a target of 1 million which would beeasily surpassed with the first quarter of 2008.

Figure 1: Bank Asya Key financial ratios and other informationforeign trade. Of total enterprises in Turkey, 99.8% are SMEs, and it isanticipated that this sector will increase leverage going forward.Profitability Ratios2004 2005 2006Return on Average Equity 25.84% 40.6% 31.1%Return on Average Assets 2.11% 4% 3.9%Capital AdequacyCapital Adequacy Ratio 10.78% 13.06% 18.6%Other InformationEmployees 1.333 1.797 2.328Branches 62 72 92Source: International Financial Reporting Standard Chartered BankRecord-breaking IPOBank Asya completed its initial public offering of 20% of its shares onthe Istanbul Stock Exchange (ISE) in May 2006. A further 3% green shoeoption was later exercised, bringing the total to 23%. Currently, 43% ofAsya’s shares are publicly traded on the ISE. Bank Asya is the first participationbank to be listed on the exchange and its IPO was one of themost sought-after offers since the establishment of the stock marketin Turkey: the most successful IPO to date with 52 times oversubscriptionof the allotment of shares, valuing the bank at $800 million. Theoffering was for $180 million with the green shoe option and strongdemand came from Europe, US and Middle East, besides domesticinvestors, totalling a massive $7.5 billion. Six months after the IPO, BankAsya’s shares became part of the prestigious ISE-30 Index. The initiationprice of Bank Asya shares was YTL 3.5 in May 2006 and the current priceis YTL 11 valuing the bank at US $2.7 billion.Asya’s overall strategy is to continue to compete in the Turkish bankingsector as a whole, rather than just with other participation banks. Todo this, Asya aims to introduce interest-free banking products to thebroadest possible customer base.In anticipation of the present interest rate environment, Asya’sstrategy has been, and will continue to be, to expand the business inthe more profitable segments such as commercial banking and to increasefee and commission income to offset lower mark-up margins.Other areas for particular focus include project and trade financing.Regarding the latter, economic growth in Turkey has led to significantincreases in international trade activity. While Asya’s current marketshare in Turkey’s international trade stands at approximately 2.1%,it is seeking to expand it over the next few years. As far as projectfinancing is concerned, Asya aims to establish itself as the leadingprovider for energy infrastructure projects.SME focusAs at the end 2006, the total amount of outstanding cash loans to commercialcustomers, consisting of corporate and SME customers, representedapproximately 88% of the total cash loan portfolio. This compareswith approximately 90% at the end of December 2005.The bank enjoys acorporate client base of more than 90,000 of which 88% are SMEs.The SME sector in Turkey is under-banked, with an estimated 6–8 %stake in the total sector loans. Bank Asya’s strategic focus since itsestablishment has been the SME sector, together with retail clients andBank Asya also provides a broad range of leasing products to supportits commercial clients’ needs. Since conventional banks are not allowedunder Turkish law to engage directly in leasing activities, Asya,as a participation bank, can conduct leasing activities more efficientlythan conventional banks operating through their subsidiaries. Asyaenjoys a strong place among top 5 banks in terms of off-balancesheet risk in the Turkish Banking system and generates 45% of itscommission earnings from non-cash loans. Asya also enters intocertain financial instruments with off-balance sheet risk to meet theneeds of customers. These include letters of guarantee, acceptancecredit and import letters of credit, along with other commitments andliabilities.International relationshipsInternational activities consist principally of establishing and maintainingbusiness relationships with correspondent banks in foreigncountries. In recent years there has been a focus on international operationsdesigned to increase domestic market share, expand productand risk differentiation, gain a greater presence in global financialmarkets and meet the changing needs of existing and potential customers.Asya maintains active business relationships with more than850 correspondent banks in nearly 100 countries.In April 2007, Bank Asya tapped into the syndication market for thefisrt time with a murabaha financing facility. 3 MLA’s were mandatedfor US $50 million and after achieving a significant oversubscriptionfrom correspondents all over the world, the facility was increased toUS $175 million. The deal was two tranches with a maximum tenorof 2 years. 40 banks participated to support Bank Asya with manyof them entering such an islamic deal for the first time from US andEurope.Since 2002, Asya has placed a great deal of emphasis on its internationaltrade activities, with special attention being paid to thecontracting sector and its foreign projects. With its strong presence inthe finance sector and this large correspondent base, Bank Asya hassecured its place as one of the leaders in international trade financeamong all banks and financial institutions in Turkey.For further information, please contactMr. Unsal SOZBIRExecutive Vice PresidentKucuksu Cad. Akcakoca SokakNo:6 Umraniye 34768 IstanbulTurkeyTel: +90 216 633 5120Usozbir@bankasya.com.trBANK ASYA • Paticipation banking: a growing sector in Turkey

London acts as globalgateway for Islamic financeAs a global financial centre, London could be expected to play a part in the development of Islamicinvestment products. The London Stock Exchange’s markets are increasingly attractive to thosewishing to invest or raise funds in a Shariah-compliant wayGiven London’s place at the heart of the international financial marketsit is not surprising that a significant part of the recent, rapid growth inIslamic finance has taken place there. The London Stock Exchange playsa key part in the City’s development as a global gateway for Islamic financeand now offers Islamic investors from Britain and beyond accessto a growing range of Shari’ah-compliant products.Since the start of 2006 the exchange has admitted14 sukuk to tradingon its markets, raising in excess of £5 billion. This year it welcomedthe UK’s first Shari’ah-compliant exchange-traded funds (ETFs). Theexchange’s capital markets are also playing an important role in financingthe development of companies from around the world, includingthe Middle East.Capital poolIslamic issuers are drawn to London for a variety of reasons. While thedesire to access the world’s most international pool of capital is crucial,the City’s principles-based approach to regulation and the wide rangeof expertise offered by London-based professionals are also importantattractions.The prospects for the future development of the Islamic financialindustry in the UK are good. London’s deep and liquid markets, excellentskills base and single financial services regulator, which is regardedinternationally as responding flexibly and pragmatically to new ideas,all help to create an environment sympathetic to the needs of Islamicfinance. This is being recognized by a number of international banks,such as Citibank, UBS and HSBC, which have chosen to set up theirIslamic banking and advisory activities in London.Government supportIn addition, with Muslims accounting for 3% of the UK’s population, thegovernment has since 2000 introduced a series of tax and legislativechanges designed to remove obstacles to the development of Islamicfinance, in a bid to create an inclusive financial system. In 2004 the UKbecame the first country to authorize a wholly Islamic retail bank in acountry where most of the population is non-Muslim. That bank, the IslamicBank of Britain, along with the European Islamic Investment Bank,is now quoted on AIM. The government’s tax and legislative frameworkhas also established a level playing field for a variety of other Islamicproducts, including mortgages, bonds and insurance.The exchange’s markets offer flexibility: international companies canchoose to issue a wide variety of different security types in London,including shares, depositary receipts, sukuk and debt. Internationalissuers also have a choice from a number of markets, including theexchange’s flagship main market; the Professional Securities Market,which is designed for the needs of professional investors; or the AlternativeInvestment Market (AIM), for smaller growing companies.Nearly 40 companies from the Middle East have opted to raise capitalon the London Stock Exchange’s markets, including a number of banksand financial services companies.Good news for investorsThe growth of Islamic finance in London is not just good for the City. Itis also excellent news for the growing number of Muslim investors fromaround the world now accessing the exchange’s markets. In December,iShares chose to issue its first Shari’ah-compliant ETFs on the LondonStock Exchange’s main market, for the first time allowing these investorsto benefit from the low-cost, instant diversification offered by arange of ETFs while investing in a way that is consistent with Shari’ahprinciples. With a typical total expense ratio of 0.85%, the iShares MSCIWorld Islamic; the iShares MSCI Emerging Markets Islamic and theiShares MSCI USA Islamic ETFs offer a cost-effective way to build anIslamic investment portfolio.The London Stock Exchange is part of HM Treasury’s Islamic Finance ExpertsGroup, which was established in April 2007 to advise the governmenton opportunities to support the development of Islamic financein the UK. The group is examining the feasibility of the UK governmentbecoming the first national government in Europe to issue a sovereignsukuk. With the government and the City actively promoting Islamicfinance, the foundations for the further development of the industry inthe UK have been firmly laid.For further information, please contactDarko HajdukovicProduct Manager – Main Market and Professional SecuritiesMarketThe London Stock ExchangeTel: + 44 (0) 20 7797 3306Email: dhajdukovic@londonstockexchange.com

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Islamic capital markets: stillbreaking recordsThe slowdown in the global capital market has yet to dent the Islamic sector, with the value ofsukuk deals doubling in 2007. Indications are that the vast infrastructure investments planned forthe Middle East and South Asia will help keep the trend on an upward pathFor the Islamic market, 2007 was another year of impressive growth,despite the sharp slowdown at the primary level of the global capitalmarket. By mid-December, total issuance in the sukuk market hadreached a record $43 billion in 177 deals, according to data published byIFIS. Although this represented a decrease on the total number of transactionscompleted the previous year (199), it represented an increaseof 80% on the amount raised in the global sukuk market in 2006, whendeals worth $27 billion were completed. That total compares with $12billion in 2005 and just $7 billion in 2004.Chart 1: Global sukuk issuance (US$ mn)50,00045,00043,13940,00035,00030,00027,16625,00020,00015,00012,03410,0007,2115,7175,0002003 2004 2005 2006 2007Source: IFIS 19 Dec 2007issuance from Africa and (predominantly) the Middle East in 2007. In2006, borrowers in the Africa and Middle East region raised a over $10billion in the global sukuk market; in 2007, this rose to almost $20 billion.In Malaysia, by contrast – which is comfortably the main source of Asiansukuk issuance – total volumes rose around 40% from $15 billion in 2006to $21 billion in 2007.Within the Middle East, the most striking development in 2007 was thevery clear emergence of the United Arab Emirates (UAE) as the centreof gravity for issuance of sukuk. In 2006, six UAE-based borrowers raised$21.435 billion in the sukuk market, with issuance driven by a smallhandful of very large transactions. Those included the highly successful$3.5 billion Dubai Ports deal at the start of 2006, led by Barclays Capitaland Dubai Islamic Bank, and the $3.52 billion transaction for Nakheel atthe end of the year, led by the same banks. In 2007, however, volumesin the UAE market for sukuk transactions exploded to $22.276 billion in26 transactions.Elsewhere in the GCC, issuance in Saudi Arabia posted a healthy rate ofgrowth from $818 million in 2006 to over $5 billion in 2007, althoughby December. Foremost among those transactions is the $4.1 billiontransaction for the fast-growing National Air Services (NAS), which in2007 placed orders for 98 new aircraft as part of a growth strategy thatwill see its total fleet expand to 142 planes by 2012.Behind the aggregate totals, however, were a number of highly significanttrends. The most striking of these was the conspicuous increase inAnother fast-growing market is Qatar, where total issuance was lessthan $270 million in 2006. In 2007, announced or issued volumeChart 2: Sukuk issuance by countryKuwait 3%Pakistan 2%Bahrain 2%2006 2007Other 2%Brunei 1%Saudi Arabia 3%Pakistan 1%Brunei 2%Bahrain 3%Other 2%Saudi Arabia 13%Kuwait 4%Malaysia50%UAE 31%Malaysia54%UAE 27%Source: IFIS 19 Dec 2007

expanded Table 1: to Largest more than Sukuks $5 billion, in 2007buoyedchiefly by a $2.5 billion dealThat was most graphically illustrated in June, when Malaysia’s stateISSUER COUNTRY TYPE AMOUNT (US$ MN)Aldar Properties United Arab Emirates Islamic Exchangeable Bond 2,530DP World United Arab Emirates Mudharabah 1,500Dubai International Financial Center United Arab Emirates Mudharabah 1,250Dana Gas United Arab Emirates Mudharabah 1,000Dar Al Arkan Saudi Arabia Sukuk Al Ijara 1,000Khazanah Nasional Malaysia Islamic Exchangeable Bond 850Nakheel United Arab Emirates Islamic Exchangeable Bond 750Dubai Islamic Bank United Arab Emirates Sukuk Al Musharakah 750Dar Al Arkan Saudi Arabia Sukuk Al Ijara 600National Industries Group Kuwait Mudharabah 475Source: IFIS, 19 December 2007announced in the summer by the Qatar Gas Transportation Company(Nakilat), to support the company’s acquisition of 54 new tankers fordelivery in 2010. With other borrowers such as Barwa Real Estate alsoannouncing plans to sell $800 million of Islamic bonds this year, Qataris likely to be one of the pivotal markets in the continued evolution ofthe sukuk market in 2008.Among other GCC economies, issuance of sukuk has remained modestin comparison with the recent explosion in the UAE. In Bahrain, for example,which since the 1980s has been a key location for the evolutionof the Islamic financial services industry, issuance in 2007 reached $973million, compared with $798 million in 2006. In Kuwait, meanwhile,volume in 2007 rose to $1.3 billion, up from a little over $1 billion theprevious year.Borrowers diversifyA number of other key trends emerged from the striking expansionin the sukuk market in 2007, led by issuance from the UAE. One ofthese was the continued diversification of the market, giving investorsexposure to a much broader range of the GCC’s fastest-growingcorporate names. Many of those corporate borrowers are categorizedby the ratings agencies as so-called government-related enterprises,giving investors exposure to credits that some regard as offering quasigovernmentrisk. Prominent examples include borrowers such as DIFCInvestments and the UAE utility, Taqa.Wholly privately-owned companies coming to the market for the firsttime in 2007, meanwhile, included those such as the Saudi Arabianconglomerate, the Saad Group, which generated demand of more than$900 million for its debut transaction led in May by BNP Paribas. Thatstrong demand allowed for the five-year deal, originally planned as a$350 million-500 million issue, to be upsized to $650 million.Another important trend that was especially conspicuous in the firsthalf of 2007 was the continued diversification of the investor base forsukuk. In the early stages of the market, the lion’s share of sukuk wasgenerally placed with ‘domestic’ or regional investors. While the Malaysianmarket has remained predominantly a domestic one, its borrowershave enjoyed notable success in tapping an increasingly internationalmarket.investment holding company, Khazanah Nasional, launched itsgroundbreaking $850 million sukuk exchangeable into a 15% stakein the toll road operator, PLUS Expressways. Led by CIMB InvestmentBank, Deutsche Bank and JP Morgan, the Khazanah transaction wasincreased from its originally planned $600 million when it generatedorders of more than $7.8 billion. Much of that demand was accountedfor by convertible funds from Europe.Global investors targetedSukuk issuance from the Middle East has also increasingly beentargeted at a global investor community. For example, an importantlandmark for the market was passed in June 2007, when BarclaysCapital, Citigroup, Deutsche Bank and Dubai Islamic Bank led a highlysuccessful $1.5 billlion sukuk Al Mudabarah transaction for DP World.This was an integral part of a $3 billion funding programme allowingDP World to refinance its existing debt, and broke new ground for beingthe first sukuk to be documented to ensure compliance with RegS and US 144A standards. According to a deal analysis published byDubai Islamic Bank, that made the DP World issue the first of its kind togive US accounts the opportunity to invest in UAE corporate securities.In total, according to the same analysis, 33% of the transaction wasplaced in the US, with a further 15% in Europe, 8% in Asia and 8% in theUK, with only 36% distributed in the Middle East.Table 2: 2007 Sukuk BookrunnersRANKING BOOKRUNNER AMOUNT (US$ MN) ISSUES1 CIMB Islamic 5,323 272 HSBC Amanah 3,808 143 Barclays Capital 2,479 64 JP Morgan 2,033 35 Deutsche Bank 1,980 66 Citigroup 1,762 57 Dubai Islamic Bank 1,102 78 Riyad Bank 1,050 19 Standard Chartered Bank 1,001 1610 Credit Suisse 960 2Source: IFIS, 19 December 2007

The growing diversification of the investor base for Islamic securities in2006, which gathered momentum in the early months of 2007, turnedout to be something of a double-edged sword. International investorsbecame increasingly nervous about committing funds to newcorporate issuance as the credit crunch tightened its global grip in thesecond half of 2007, which had an inevitable knock-on impact on thesukuk sector at both the primary and secondary level. Issuance of newsukuk slowed in the second half of the year, while spreads of thoseinstruments that had been widely placed among international investorswidened. That widening, bankers in the Middle East rightly insisted,was purely a reflection of global liquidity flows, rather than of any shiftsin the underlying credit quality of issuers in the sukuk space. After all,buoyed by high oil prices and economic diversification, growth in theInfrastructure prospectsLooking to 2008 and beyond, there is a growing belief that one of themost exciting areas for Islamic finance will be as a means of financing thegigantic infrastructure investments that are now either being implementedor are on the drawing board throughout the Middle East. Estimates ofthe total investment that will be channelled by public and private sectorinvestors into infrastructure in the Islamic world vary, but a recent reportpublished by the Dubai-based Abraaj Capital describes the requirementin the Middle East, North Africa and South Asia as “nothing shortof spectacular”. The Abraaj report says that “in the first half of 2006, theMiddle East, for the first time in its history, became the largest source ofinfrastructure related project finance in the world, accounting for $33 billion,or one dollar for every three that was raised in the industry globally”.“One of the most exciting areas for Islamic finance will be as a means offinancing the gigantic infrastructure investments that are now either beingimplemented or are on the drawing board throughout the Middle East”Middle East in general and the GCC in particular continues to outpacemost of the rest of the world.Over the coming decade, adds the Abraaj analysis, the MENSA regionwill call for infrastructure investment of more than $630 billion acrossa number of key economic sectors. Power and utilities will account forOne notable positive by-product of the growing risk averseness ofglobal investors in the second half of 2007 was the increased flexibilityof borrowers in the sukuk market. In the case of a transaction launchedin November by the Jebel Ali Free Zone (JAFZ), led by Barclays Capital,$155 billion of this huge total, with the other areas identified as havingsubstantial investment requirements including water ($133 billion),healthcare ($49 billion), education ($18 billion), transportation ($188billion) and petrochemicals ($87 billion).Deutsche Bank, Dubai Islamic Bank and Lehman Brothers, the anticipationof weak international demand did not lead to a cancellation of thedeal. Instead, it led to its denomination in dirham rather than dollars,with the transaction eventually offered as a very successful Dh7.5billion ($2 billion equivalent) floating-rate note (FRN), which made theJAFZ deal the largest ever non-convertible sukuk, with local investorsaccounting for 62% of distribution.Much of the focus for investment will inevitably be concentrated onthe Middle East, but the populous and fast-growing Indian economyalso has a massive infrastructure requirement. The government hasrecently put the size of that requirement at $500 billion between 2007and 2012, meaning that some 9% of GDP will need to be invested ininfrastructure over the next five years.Table 3: Key project financing transactions in 2007Project Country Sector AMOUNT (US$ mn) Type of FinancingIndian Economic Zone India Infrastructure 10,000 Islamic Financing FacilityEnergy City China China Power 5,000 Istisna’aTunisian Financial Harbour Tunisia Real Estate - Commercial 3,000 Islamic Financing FacilityDeyaar Park UAE Real Estate 3,000 Istisna’aSaudi Telecoms Saudi Arabia Telecommunications 2,500 Murabaha FacilityAl Raha Beach Project UAE Real Estate 2,100 IjarahLeisure & real estate projects UAE Real Estate 1,850 IjarahRoyal Metropolis Jordon Gate Jordan Real Estate - Residential 1,000 Islamic Financing FacilityDurrat Al Bahrain Bahrain Real Estate - Residential 1,000 Islamic FundBarwa Real Estate expansions Qatar Real Estate 800 Murabaha FacilityDubai Business Park UAE Real Estate - Commercial 700 Islamic Financing FacilityLow Sulphur Diesel Production Facility Bahrain Oil & Gas 685 IjarahQueen Alia Intl Airport Expansion Jordan Infrastructure - Airports 680 Islamic Financing FacilityEthylene-Glycol Plant Saudi Arabia Petrochemical 650 Istisna’aMarafiq IWPP Saudi Arabia Water & Power Plants 600 Islamic Financing FacilitySource: IFIS, 19 December 2007Islamic capital markets still breaking records11

Table 4: Main real estate project financing transactions signed during 2007Project Obligor Country Amount (USD$ Mn) Type of FinancingCapital Injection Nakheel Group UAE 350 IjarahPark Corner Development Test Contracting Company UAE 22 Islamic Financing FacilityGrowth Opportunity Plans Tamweel PJSC UAE 463 Islamic Financing FacilityGlomac Tower Glomac Al Batha Malaysia 23 Istisna’aLeisure & real estate projects Nakheel Group UAE 1,850 IjarahProperties in the Holy Haram area Munshaat Real Estate Company Saudi Arabia 100 Revolving Murabahain Makkah & MadinahSource: IFIS, 19 December 2007Quantifying how much of the world’s infrastructure investment willbe financed through Islamic instruments or Islamic project finance ishazardous, but IFIS puts the potential into perspective in its analysisof completed or announced deals in 2007. In the project and infrastructurefinancing category, these indicate that transactions worthalmost $56 billion had been issued or announced by mid-December2007, through a variety of instruments ranging from sukuks to Ijara(leasing), Istisna’a (contracts of exchange) and morabaha (trade-based)structures and more straightforward syndicated or bilateral Islamicfinancing facilities.Those transactions were also spread across a very diversified range ofgeographical regions. For example, the IFIS inventory of projects signedor under construction by December 2007 include the $10 billion IndianEconomic Zone initiative, a 1,600-acre zone to be developed nearMumbai and supported by an Islamic financing facility for which theBahrain-based Gulf Finance House (GFH) has been appointed as mandatedlead arranger. Another project outside the Gulf being supportedby an Istisna’a facility is the $5 billion Energy City China development.It is, however, the GCC that accounts for the bulk of ambitious projectsunder development that are being financed in some shape or formwith structures compliant with Shariah law. The largest of these, accordingto the IFIS data, include projects such as the Al Raha Beachproject in Abu Dhabi, a major mixed-use development being buildalongside 8.5km of natural beach-front that will house over 120,000residents. In June 2007, Dubai Islamic Bank and Morgan Stanley wereappointed mandated lead arrangers on a $2.1 billion facility for AldarProperties, which is developing the Al Raha project. In common with anumber of the region’s big-ticket project-related financings, this wasdivided into a $1.267 billion conventional tranche and an $833 millionIslamic facility – both of which were healthily over-subscribed, with theentire package generating commitments of $2.84 billion.Real estate potentialIn data analyzing the growth of the Islamic capital market, real estatefinance is often bundled together with the broader infrastructure market,and general consensus among bankers is that residential and commercialmortgage-backed structures are likely to develop into a verypromising area for Islamic finance. Throughout much of the MiddleEast, in particular, residential mortgage markets remain very immaturerelative to Europe and the US, and fast-rising demand for home ownershipacross all segments of society in a number of countries is expectedto lead to rapid development in regional mortgage markets.A handful of Islamic securitizations have already been structured, bothin the Middle East and Malaysia, where the Cagamas MBS BerhardMYR2.11 billion Islamic residential mortgage-backed securitisation wasseen as an important prototype for the market.As Standard & Poor’s (S&P) observes in a recent report on the sukukmarket, “both conventional and Islamic financial institutions mightincreasingly turn to this category of sukuk in the future, especially ifportfolios are built on a larger scale; credit information pertaining tothem is collected, stored and documented; and the underlying legalframework is supportive, particularly of the legal isolation of assets forthe benefit of investors”.Table 5: Mandated Arrangers for real estate financing during 2007Ranking Mandated Arranger Amount (US$ mn) Projects1 Dubai Islamic Bank 1,020 42 National Bank of Abu Dhabi 790 23 Standard Chartered Bank 471 34 Morgan Stanley 420 14 First Gulf Bank 420 14 Abu Dhabi Commercial Bank (ADCB) 420 15 Emirates Bank Group 370 15 Barclays Capital 370 16 ABC Islamic Bank 363 37 Unicorn Investment Bank 276 3Source: IFIS, 19 December 2007

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The potential ofBancatakafulWith conventional insurance increasingly regarded as being incompatible with Sharia law, takafulis finding favour among Muslims across the globe and becoming an important product for banksseeking to provide for all their clients’ financial needsTakaful, or insurance based on the principle of mutual assistance, is oneof the most dynamic areas of the broader market for Islamic financialservices. As Moody’s noted in a recent report, “Takaful … has shown veryimpressive premium growth rates of about 20% in recent years. The firsttakaful company was established in 1979 and now there are over 250globally. Total takaful premiums exceeded $2 billion in 2005, and areexpected to reach $7.5 billion by 2105.”A more recent analysis published by Fitch puts the total global takafulcontributions at about $2.6 billion in 2006, which the agency describesas “very small compared with the world’s insurance sector as a whole”.However, Fitch adds that takaful’s “influence and importance extendswell beyond its current size, and there is substantial potential for growthboth in Muslim communities in the Middle East and Asia as well as insome more mature markets (eg, in France, Germany and the UK), whichhave significant Muslim minorities”.Among other ratings agencies, a bullish report on the prognosis for takafulin the Gulf Cooperation Council (GCC) countries published in April2007 by Standard & Poor’s (S&P) notes that the market in the Gulf aloneis growing at about 40% a year. That, says S&P, means the GCC market“has the potential to reach $4 billion at the current level of development(currently $170 million)”. Much of this growth in the GCC will be driven bychanges in legislative frameworks which have, for example, introducedcompulsory health insurance for expatriates in the UAE and mandatorythird-party motor insurance in Saudi Arabia.Globally, growth will be underpinned by a range of other key influences.Powerful economic growth and reform in the financial sector throughoutthe Islamic world is driving a conspicuous increase in the market forinsurance policies arising from trends such as the surge in demand forSharia-compliant mortgages. That surge is visible not just in marketssuch as Malaysia and in the Gulf, but also in some areas of westernEurope. Datamonitor has forecast that in the UK, for example, grossadvances in the Islamic mortgage market will shoot up from £164 millionin 2004 to almost £1.6 billion by 2009.Hand-in-hand with this skyrocketing demand, however, will be the increasinglywidespread recognition that conventional insurance is in conflictwith Sharia law for at least two key reasons. The first is that traditionalinsurance is perceived to be founded on principles associated with “gharar”(uncertainty or ambiguity), while the second is that the investment policiesof conventional insurance companies are based on fixed-interest productsproscribed because of their reliance on “riba” (interest).Bancatakafal definedHistorically, the growth of the takaful industry has been driven by thedistribution of products through a number of channels owned andmanaged by dedicated takaful companies. Today, however, the industryis gravitating increasingly towards bancatakaful – Islamic financialservices’ equivalent of bancassurance – and the distribution of familytakaful-linked investment plans. Bancatakaful is defined as the deliveryand distribution of a suitable range of tailored, bankable protectionand long-term savings and pension products designed to meet the lifecycleneeds of the individual customer base of a bank or other financialinstitution.The reasons underpinning that trend are easy to identify. Banks areincreasingly committed to meeting the overall financial planning needsof their customers on one hand, and generating stable, fee-based incomefor their own business on the other. Self-evidently, the capacity to tailorsuitably diversified risk/reward investment portfolios, select top quartileperforming funds from major international brands and control definedportfolio risk levels are all powerful drivers for the retail value proposition.That proposition can only be further strengthened by productcertification by an independent Sharia board of experts and ongoingmonitoring of the product’s compliance with Sharia law.White-labellingIt is equally self-evident, however, that the number of product providerswith the necessary expertise to provide this comprehensive service islimited. That is why one increasingly important driver of growth in themarket will be the evolution of white-labelling – the creation of productsby one company and their rebranding and distribution by another.There are a number of persuasive reasons why banks are likely to favourthe white-labelling option. Long-standing customers will inevitably feelmore comfortable with their banks’ own brand than with that of a newcomer,while banks themselves are able to use white-labelling to blendtheir own Islamic mutual funds with high-quality and top-performingthird party Sharia-compliant funds. Additionally, white-labelling meansthat all customer assets of the family takaful-linked investment businessremain within the bank’s custody, which may also gain the corporatebank account of the life insurance company supplying the product.Other advantages for banks in pursuing the white-labelling model arethat the life cycle nature of the product will allow them to enhance customerrelationships and therefore underpin client retention rates. Banksexploring white-labelling of takaful products will also gain access to the

fast-growing web-based point of sale (POS) and online administrationsystems without having to incur the costs of integrating new systems orbuilding new interfaces.The expansion of white-labelling in the takaful industry has been supportedby the growth of call centres and mobile phone services, whichare helping to promote broader distribution and enhanced transparencyacross the sector, with many Islamic financial institutions havinginvested very substantially in the roll-out of 24/7 ‘virtual’ channels inrecent years.help to further build” the retakaful segment of the Islamic insuranceindustry.Another challenge that stands in the way of rapid growth in the takafulindustry arises from the interpretation of Sharia law. Although progress hasbeen made in the development of non-life savings-related products, there isstill a widespread belief across the Muslim world that life insurance is forbiddenunder Islamic law. Gradually, products are being developed that arebeing tailored in a way that is acceptable to Sharia experts, suggesting thatthe longer-term prospects for takaful life insurance products are promising.“Powerful economic growth and reform in the financial sector throughout theIslamic world is driving a conspicuous increase in the market for insurancepolicies arising from trends such as the surge in demand for Sharia-compliantmortgages”Although the distribution of takaful life and savings products throughbank channels is a relatively new phenomenon, a number of initiativesare already demonstrating that the advent of POS and online administrativesystems are supporting the sales process through branchnetworks. An example is the “Meethaq” Takaful and Savings Programmeunder which the Abu Dhabi Commercial Bank (ADCB) is offering investment-orientedlife takaful products to UAE residents in a joint venturewith the Dubai Islamic Insurance and Reinsurance Company and FWUGroup. For regular contributions starting at as little as AED500 ($136) amonth, ADCB’s customers can make their own choice from three Shariacompliantsavings strategies which – according to ADCB – allows saversto combine “a lifestyle savings plan with personal takaful protection forcomplete peace of mind”.Challenges to be overcomeWhile the general consensus is that the outlook for the global growthof takaful is bright, a number of challenges still need to be addressedif its potential is to be realized. For example, one growth area that hasyet to be developed is the market for pure retakaful solutions, or Islamicreinsurance, allowing for the immunization of originally insured risks.Progress has been made with, for example, the launch at the end of2005 of the Dubai-based Takaful Re, which is rated BBB by S&P andreported a net profit of $1.263 million in its first full year of operationsin 2006. Others that have entered the global retakaful sector recentlyinclude international companies such as Tokio Marine, Swiss Re, ConveriumMunich Re and Hanover Re.Nevertheless, more retakaful solutions would clearly make a very positivecontribution to the evolution of the global takaful industry. Asa recent report published by Fitch explains, “this kind of capital andpricing support is especially valuable in the case of takaful because suchbusinesses currently tend to be relatively small niche operations ands insome cases have expertise in Sharia compliance rather than in insuranceunderwriting and pricing”. Fitch says that it expects a developing retakafulsector “may well lead to greater takaful capacity which will, in turn,A further stumbling block to the development of the takaful sector hastraditionally been the fragmented regulatory environment for the industry.The Islamic Financial Services Board (IFSB) and the InternationalAssociation of Insurance Supervisors (IAIS) have addressed this issue bydrawing up a global, uniform set of regulations, which will enhance thetransparency and global marketability of takaful products.Continued internationalizationIn spite of these challenges, one very encouraging pointer to the futuregrowth of the market has been the commitment that a number of thelargest multinational insurance companies are now making to its development.AIG Takaful, a subsidiary of the world’s largest insurer, AmericanInsurance Group (AIG), was awarded a licence by the Central Bankof Bahrain in July 2006, and has focused largely on accident and health,motor, personal contents, property and casualty insurance. Europeanheavyweights such as Allianz and AXA are also becoming increasinglyactive in the market. Leading UK insurers have also underscored theirconfidence in the Malaysian market through the establishment of jointventures such as CIMB Aviva Takaful and Prudential BSN Takaful.For further information, please contactDr. Manfred J. Dirrheimer Sohail JafferChairman, FWU GroupPartner, FWU GroupBoschetsrieder Straße 67 4a Rue Albert BorschetteD-81379 Munich L-1246 LuxembourgTel: +49 (0) 89 7485880 Tel: +352 26197701Fax: +49 (0) 89 74858881 Fax: +352 26197801FWU GROUP • The potential of Bancatakaful15

For more information about Euromoney research guides,please contact Akbar Ahsan at the address below:2007 Guide titlesGuide to opportunities and trends in Islamic financeGuide to technology in treasury managementGuide to financial supply-chain managementGuide to property derivativesGuide to best practice in foreign-exchange marketsGuide to Greece & south east EuropeGuide to BrazilGuide to leveraged financeBrazil, Portugal & Spain: The partnership growsGuide to Corporate advisory in the ASEAN regionGuide to Investing in Headge FundsGuide to TurkeyGuide to financial terminology from A-ZGuide to Corporate governance in the GCCGuide to Exchange traded fundsGuide to PortugalGuide to Private bankingGuide to debt financing in Latin AmericaGuide to Portugal: The EU presidencyGuide to SEPA: Becoming a realityGuide to Innovations in treasury managementGuide to Cash management in CEEGuide to Corporate social responsibilityJanuaryMarchAprilAprilMayJuneJuneJuneJulyAugustAugustAugustSeptemberSeptemberSeptemberSeptemberSeptemberSeptemberOctoberOctoberOctoberDecemberDecemberEuromoney Research GuidesTel: +44 20 7779 8118Fax: +44 20 7779 8345Email: aahsan@euromoney.com