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2010/10/19

Sukuk and Islamic Investment
By Rose Anderson


Islamic finance govern by Shari’ah law , as per Shari’ah law interest is strictly restricted in Islam.Free debt help is allowable without taking any interest, or these can be treat as to help anyone, without taking any interest from the lender. As interest is against the Islamic law bond market not develop in the Islamic world. Most of the Petroleum exporting countries are investing there surplus amount in the US free debt help bonds and they not taken interest on investment. Sukuk is invested to protect the religious value and also to increase the Muslim investment market.Malaysia is the largest issuer of the sukuk bonds ,sukuk is not only famous in islamic market but also some European and American countries issued sukuk bonds to get the islamic investment of rich middle east countries.Sukuk is also consider as a portfolio investment to diversify the investment.

A major challenges facing Islamic financial products like sukuk bonds are the lack of liquidity.According to S&P, there are more sukuk listed in Dubai than any other else, but the secondary market is virtually non-existent. Further, the bulk of sukuk are over-the-counter instruments,with listed sukuk accounting of only 20-255 of outstanding sukuk is issued worldwide; that is, $10-15 bn so far, says the rating agency. Zeti contends that creation of persistent supply of Islamic papers and instruments that would upgrade the secondary trading of instruments and greater depth of the market is the hour. According to her, another factor that could help futher expand the market for Islamic finance products would be to bring in greater diversity in the market for Islamic financial institutions and portfolio manager to manage their funds effectively. Pricing issues also pose significants challenges to the unhindered growth of the market. There is the need for developing a relevant benchmark for efficient and credible pricing. For example , if sukuk is issued based on the Ijarah principle, and if it uses the property as its underlying assets then actual rate of rental may be explored to be used to determine the rate of return on the instrument. However, it may then fluctuate depending upon the demands and supply for that property. Shari’ah experts, who have a full understanding of the mechanics of sukuk, should play an important role in ensuring its proper pricing as well as governance, she suggests.

Taking Islamic finance products global is another challenges as it requires harmonization of standards and practices between those of regional Islamic finance and international standards. Zeti suggests that full support has to be accorded to the international standard setting organizations such as Islamic Financial Service Board (IFSB) and to the Accounting and Auditing Organization for Islamic Financial Institution (AAOIFI) to formulate appropriate standards that would strengthen the Islamic Financial system.The Malaysia based IFSB has already formulated the prudential treatment for sukuk investment by the Islamic Financial Institution s as specified in the Capital adequacy standards and has also undertaken a set of initiatives to strengthen the framework and practices in the Islamic money market.

Also, lack of rating is another major issue. Given the complex legal structure, it adds to the cost and complexity of rating. Further rated instruments are almost non-existent in the Middle East.
However, global rating agencies such as S&P, however, feel that there is a way out. “the provisions of Islamic debt instruments may add level of complexity to rating analysis long stading methodologies and rating scales are sufficiently broad so far to incorporate the varied features of Islamic debt financing,”It said in recent report. Islamic finance largely centers on assets-backed approaches and sometimes involves a degree of risk-sharing more commonly born by equity investors.In practice,however,as illustrate d in the sukuk that Standard & Poor’s has rated, binding guarantees and other contractual obligations can place transactions firmly in the debt category.

R. Anderson is a financial writer .She is the Community Member of "Debt Community" and has been contributing her suggestions to the Community . She has also made notable contributions through various articles written on different subjects related to debt industry.

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2010/10/17

Coming of age
Past challenges, future opportunities
By Dr. John Lee and Anita Menon (KPMG Malaysia)

Last year may go down in history as the watershed year for the financial services industry. However, as Dr. John Lee and Anita Menon explain, while Islamic finance was not entirely unscathed by the vagaries of the economy and the contagion effect of the conventional finance sector, the industry still recorded compounded annual growth rates of 28 percent from 2006 to 2009. Islamic banks also recorded an increase in assets by 28.6 percent in 2009 to US$822 billion.1

This in itself is interesting, as a couple of years ago at the height of the previous growth cycle for Islamic finance, many felt that the true test of the resilience of the system would be when there was a shock to the system, and when the liquidity in the Middle East dried up. However, skeptics would also claim that this was due to Islamic institutions general investment prohibitions which meant that they were less exposed to subprime assets.

2009 also saw the entrance of a number of new players which indicate that interest in this burgeoning sector is as yet, unabated. As at end 2009, there were 1,124 Islamic financial institutions globally.2 While issuance of sukuk3 dropped in 2009 on the back of tightening liquidity and concern on possible defaults, the demand for quality sukuks continued to be there and issuance increased by 40 percent for the first 10 months of the year, as compared to the corresponding period in 2008.4 Saudi Arabia led the issuance followed closely by Malaysia; with one of the largest issuances by Malaysia’s national oil and gas company Petronas totaling US$1.5 billion.

Figure 1 - Total Sukuk Issuance by Country in 2009




Source: S&P’s Europe, Middle East, and Africa Markets Outlook 2010, January 2010.



Outlook for the rest of this year and into 2011

The outlook for the remainder of 2010 remains positive with some analysts saying5 that Saudi Arabia is expected to continue to lead issuance, although investors are expected to be somewhat spooked by the recent Dubai World crisis, sukuk defaults and the problems seen to be encountered by some of the institutions in the Middle-East. Dar-Al Arkan, Saudi Arabia’s largest property developer by market value, successfully issued a sukuk in February this year raising US$450 million and analysts believe that the number of issuances for the rest of 2010 is likely to grow to pre-crisis levels.

KPMG in Malaysia’s analysis indicates that the Islamic finance market is steadily growing both deeper and wider, with the emergence of new Islamic finance markets such as the Maldives, Korea, Kenya, Nigeria and also stronger interest from EU countries like France and Italy. Korea for instance, is currently working on amendments to its legislation that may see the first Korean sukuk being issued as early as 2010 or 2011. In Malaysia, the interest continues to grow and, among the recent liberalization measures is the issuance of two new Islamic banking licenses to foreign players; with a paid-up capital of at least US$1 billion, along with two family Takaful licenses towards the middle of this year. Malaysia continues to be a leading market outside the Middle East with assets of almost 11 percent of the global market and with Islamic assets making up almost 19 percent of the banking and finance market in Malaysia. However, the UK is emerging as a key market holding close to 2.5 percent of global assets.6

Within the Asia-Pacific region, relative newcomers such as Singapore and Hong Kong have expressed their desire to also become centers, while the most populous Muslim nation – seen by many as the next big growth zone – Indonesia has still a long way to go if estimates of asset size are anything to go by. Bank Indonesia, the central bank of Indonesia, has indicated that shariah assets are projected at US$7.6 billion as at end 2009, which places the nation’s Islamic finance assets at 2-3 percent of the total banking assets.7 This is attributed to the nascent infrastructure and regulatory system for Islamic finance. While there is a new law which was set to be effective in April 2010 that would remove the double-taxation on some Islamic banking transactions, there are still issues around this area that hold back the otherwise huge untapped potential in this country.

Figure 2 - Total Banking Assets & Islamic Banks by Country in 2009

Source: The Banker, The Pew Forum, Bank Negara Malaysia, FSA, Central Bank of Bahrain, November 2009.

The global Muslim population is continuing to grow faster than the non-Muslim market; recent estimates place the Muslim population at 1.57 billion, 23 percent of the global population.8 There is also a large Muslim population in the Asia-Pacific region - China for instance has more Muslims than Syria; while Russia has more Muslims than Jordan and Libya combined. This translates to immense opportunities for shariah compliant finance in as yet untested markets. The potential for Islamic finance continues to be enormous. The only impediment to its growth may be that the conventional regulatory structure is currently unable to support the introduction of Islamic products.

Through the adoption of a progressive face as opposed to an overtly religious tone, in countries such as Malaysia, the Islamic finance industry has continued to make inroads in the non-Muslim market. This may also be the approach adopted in countries such as India and certain African countries with large Muslim populations, but, where the projection of an Islamic face would be anathema to the political regime.

Islamic finance is also gaining acceptance where it is seen as an ethical alternative to the conventional system, bridging the gap between socialism and capitalism. According to the Vatican’s official newspaper Osservatore Romano in its March 2009 issue, “The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service.” Ethical investors also are drawn to the principles that underlie Islamic financial transactions. Therefore growth is expected to come from this segment of consumers as well who are not necessarily attracted by its faith-based appeal, but more from its socially responsible outlook.

The future of Islamic finance

The ongoing debate on whether products are shariah compliant or shariah based and the lack of standardization, continues to be an issue. Additionally, other major hurdles that remain or have become more apparent with the recent financial meltdown include:

  • the need for robust risk management practices that would be able to drive product innovation and development;
  • the need for a legal and regulatory framework for dispute resolution, especially on cross-border transactions;
  • the ongoing requirement for trained practitioners in this field that have a strong understanding of shariah requirements, but are also in tune with market and consumer demands.

Notwithstanding that, many Islamic institutions are expected to undergo a transformation in their approach and strategy, and more importantly in their business models as well. This will enable them to encompass more of the ideals of shariah principles and to move away from the predominance of debt-based structures as in the past. When Islamic finance was first introduced into the market, the approach was to adopt products that were familiar to the generation of consumers and clients brought up on conventional financial products. Therefore, Islamic financial products were shariah compliant mirrors of their conventional equivalents. Furthermore, the initial target market was retail customers who are generally risk-averse and therefore, fixed rate products were more appealing to this segment of the market.

Increasingly however, a radical shift from the current norms will be required and this would fuel the anticipated growth in Islamic finance. The pursuit of social objectives would gain emphasis alongside the pursuit of commercial objectives; since Islamic finance is meant to be the antithesis of the previous conventional financing norms – where excessive risk-taking led to the ultimate downfall of many players. The financial crisis has heightened the interest in Islamic finance and it’s future; the concepts of risk-sharing should be ingrained further through the development of more profit and risk sharing mudaraba and musyaraka products. This would require a shift in banking business models as well. Increased product sophistication and market awareness-building would also need to go hand-in-hand with the advancement of the financial and legal infrastructure.

Over the next 18 months Islamic finance institutions are expected to come of age

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