Introduction - Euromoney Institutional Investor PLC

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Copyright of Euromoney Institutional Investormarket is rising. The bank only has its initial funding repaid, its gain accruing from therent. Arrangement and management costs are covered by set up charges and theadministrative fees. In other forms of musharakah all parties share in any capital gains orlosses, but this is not acceptable to most property buyers who anticipate long-term assetappreciation.Shariah-compliant capital market productsThe major development in Islamic finance in the last decade has involved the issuance ofsukuk Islamic securities and a methodology for ensuring that equity investment can beshariah compliant.Sukuk are based on Islamic financing structures such as salam, murabahah, ijara,mudarabah and musharakah which are securitised so that apart from salam sukuk, theycan be traded in a market. All sukuk must be asset backed to be shariah compliant andhence buyers and sellers are not merely trading financial instruments but a title to a realasset such as piece of real estate, buildings or equipment. Salam sukuk are similar totreasury bills but provide a mark-up for the investor rather than interest. Unlike treasurybills they cannot be traded as indicated above, as the asset is only delivered in ninety dayswhen the sukuk matures and is not in possession of the investors. Murabahah sukuk havea fixed return and correspond to bonds, while with ijara sukuk returns vary which meansthey have the financial characteristics of floating rate notes. These have proved the mostpopular type of sukuk, not least because returns usually vary in line with changing marketfunding costs.The main concerns of shariah scholars with sukuk is that the investors have a clear title tothe underlying asset and that in the case of mudarabah and musharakah the assetsthemselves are re-valued so that the investors do not merely get the nominal value oftheir investment refunded as with a debt instrument. This creates a dilemma for theinvestors, as those wanting shariah-compliant debt instruments do not wish to invest in8
Copyright of Euromoney Institutional Investorassets subject to market risk, their preferred exposure being to default risk only. TakafulIslamic insurance operators, for example, cannot take too much exposure to market risk,as although a proportion of their holdings are in equities, most are in sukuk for the samereasons as insurance companies hold bonds and floating rate notes. If there wereexcessive holdings of equity instruments and the market value of these investments fell,takaful operators would no longer be able to fulfil their obligations to those policyholdersmaking claims. This would mean a breach of contract and would be unfair to those inneed of accident or other compensation. Those who argue for all sukuk being equitybasedneed to be aware of the wider social and legal consequences. Land or buildingsmay be used as the underlying assets for sukuk, but investors wanting exposure to realestate may prefer to invest directly in this rather than in sukuk. From a portfolioperspective sukuk have to be viewed as one component of a multi-asset allocationstrategy.Implications of financial market volatility for IslamicinvestmentSukuk issuance has increased enormously since 2000, with over 200 issues in 2007 aloneworth $45 billion. Much of the activity was in the first seven months of the year however,as sukuk issuance after August was adversely affected by the crisis in securitized debtobligations resulting from the sub-prime defaults. The pricing of sukuk has been linked tothat of conventional debt securities, as sukuk represents only a small proportion of theoverall market, and therefore sukuk issuers and investors are price takers rather than pricemakers. The higher price which needs to be offered for sukuk financing has deterredmany issuers, with funding plans either abandoned as projects are rethought, orpostponed until market conditions become more certain.The slow-down applied especially to US dollar denominated sukuk, the currency for mostsub-prime debt, but issuance in other currencies has been affected less. Malaysian sukukare mostly local currency denominated, and appear to be unaffected, and in the Gulf there9
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Introduction - Euromoney Institutional Investor PLC

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