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Saturday, 24 December 2011

Sukuk market is the fastest growing segment of international finance

"The sukuk market is the fastest growing part of Islamic finance. Indeed it is one of the fastest growing segments in the global financial market. Having attracted interest from the business community worldwide, it has helped place Islamic finance as a viable industry and as an asset class that is not confined to Muslim countries but as part and parcel of the international financial market," says Muhammad Al-Bashir Muhammad al-Amine, who is currently group head of Shariah compliance at Bank Al-Khair (formerly Unicorn Investment Bank) in Bahrain, in the introduction of his book titled “Global Sukuk and Islamic Securitisation Market - Financial Engineering and Product Innovation”.
The book is the latest analytical offering on the subject of sukuk and was published by Brill under its Arab and Islamic law series. The claims in the above paragraph are in contrast to the outrageous claim on the cover of the book that "The sukuk market is the fastest growing segment of international finance".
Much of the literature on the contemporary Islamic finance industry has had the unfortunate tendency of excessive eulogizing of the virtues and values of the Islamic system of financial and economic management based on descriptive rather than empirical and philosophical analysis. At the same time the style also bordered on exaggerated claims about the Islamic finance industry and its role and impact on the global financial system.
To be fair, some of the literature on Islamic finance and economy in the last decade or so has shown a remarkable improvement and in some cases have even threatened to offer a valuable alternative to the cornucopia of literature on the political economy, finance, development and the market - written largely from a neo-liberal or purely Keynesian or monetarist capitalist point of view.
While Al-Amine's “Global Sukuk and Islamic Securitization Market - Financial Engineering and Product Innovation” does not necessarily fall into any of the above categories, it is important to put some of his initial claims in perspective. The sukuk market may or may not be the fastest growing component in Islamic finance. There has been very little empirical research done on this and much of the statistics are extrapolations from aggregate figures issued by some individual securities regulators ort professional associations or by some information, data and news outlets.
The base figure at the same time for sukuk originations is very low - there are about $120 billion to $150 billion of sukuk outstanding in the world today of which over 60 percent are from Malaysian issuers. Compare this to the several trillion dollars each conventional bond market and the hedge fund market.
At the same time, the commodity Murabaha and Tawarruq market remain the single largest markets in the Islamic finance industry with an estimated $1.2 trillion of funds invested.
Similarly, the interest from the business community worldwide has been at best curiosity of a potentially interesting new fund-raising asset class, but in reality this interest has translated into a peripheral acceptability of and involvement in the sukuk market. How many Western or non-Muslim  corporate/multilateral/quasi sovereign sukuk issuances, for instance, have come to the market? Hardly enough to count on both hands - Saxony Anhalt, East Cameron Partners, International Innovative Technologies (IIT), GE, Nomura, IFC, World Bank, Shell Malaysia and Tesco Malaysia. This is hardly the stuff of sukuk as a wild fire accelerant of global finance.
The point I am trying to make is that sukuk market dynamics is as complex as other asset classes whether in Muslim jurisdictions or non-Muslim ones. These relate to a cornucopia of issues - regulatory framework, enabling legislation, ratings, Shariah structures, purchase undertaking, guarantees, especially third party Sukuk guarantees, SPVs (special purpose vehicles), trust laws, court procedure (in case of defaults and recourse to law especially for different creditors), listings, secondary market, arbitration clauses and so on.
As such, any analysis will have to start from the basic proposition of the dynamics of the issuer jurisdiction, and these vary dramatically from country to country. Most Muslim jurisdictions for instance do not have Sukuk legislation in place, let alone tax neutrality or even the basic Islamic banking laws in place. Saudi Arabia, the world's largest Islamic finance market in terms of assets and liquidity, does not have a dedicated stand alone Islamic banking law in place, although its Sukuk law was designed in tandem with the debut sukuk offering of SABIC (Saudi Basic Industries Corp.), the world's largest exporter of petrochemicals, the SR3 billion SABIC I Sukuk issued in 2006. At the same time there are serious barriers to entry for investors in Saudi public Sukuk offerings because these are by law restricted to Saudi nationals and in the odd exception extended to GCC citizens.
These should not detract from Dr al-Amine's prodigious effort contained in 10 hefty chapters. These cover the growth of Islamic finance; concept and development of the sukuk market; Shariah basis for sukuk structures; sukuk structures; Global PLS sukuk structures; Securitization and sukuk; governing law in sukuk structures; Shariah convergence; risk factors in Sukuk Structures; and rating sukuk. These chapters contain valuable information and analysis, although the author could have been more forthcoming and thorough in the frankness of his conclusions and projections.
Even with this effort, there are a number of gaps - nothing on regulatory and legal frameworks (or the lack of them) which is an essential prerequisite to the development of an onshore sukuk or Islamic capital market. There is very little discussion of credit enhancement in sukuk structures through third party guarantees such as the initiative being contemplated by ICIEC and by Danajamin, the Bong and Sukuk Guarantee Agency in Malaysia.
Even in the governing law in sukuk structures, the examples used are curious - the Shamil/Beximco and TID/Blom Bank cases - these involved Murabaha and Wakala arrangements and not sukuk. Instead the legal issues raised by the default of the East Cameron, TID, IIG and the SAAD/AlGosaibi Sukuk issuances should have been covered in this chapter.
The East Cameron does get a cursory treatment in the Chapter on Securitization and Sukuk although the underlying issues are not discussed adequately especially the structure, the legal and the Shariah aspects. For instance, how come the lawyers for East Cameron Partners in the Chapter 11 Bankruptcy proceedings requested a ruling "that the sale of the ORRI (overriding royalty interest) was in essence a secured loan and not a 'true sale'". Surely this raises questions or at least an analysis of the Shariah basis of the structure and whether indeed the scholars were provided the relevant and complete information prior to them approving the Shariah basis of the structure. If not, investors and creditors may have been liable to claim compensation on the basis that the transaction was fraught with Gharar in that there may have been improper disclosure relating to the transaction.
The author rightly concludes that the growth of Islamic finance had outpaced that of the conventional industry in several countries and regions (the Middle East and Southeast Asia) in recent decades. This growth, he says, is likely to continue "at a furious pace in the coming years as the present size of the industry represents only a very small percentage of the overall global financial market place." His optimism is underpinned by his prediction that "this change will perhaps take place rather more quickly than many may expect," although he does not offer the reasons for this optimism, especially at a time when many Muslim countries are faced with volatility partly precipitated by the so-called Arab Spring events.
To the author, the holy grail of the future development of Islamic finance is the sukuk market, although the underlying assumptions on market growth and the involvement of the West are over-optimistic and empirically unproven and at best ambiguous. In his mitigation, Al-Amine rightly warns that "for the sukuk market to develop we need a robust market infrastructure in the region ns where Islamic finance is witnessing its rapid growth." At the same time this will also depend on developing a strong bond market in these regions; the Shariah legitimacy and authenticity of sukuk structures; a better engagement and discourse on sukuk structures by AAOIFI and the OIC Fiqh Academy, perhaps moving towards a more scientific way of issuing and developing fatwas in Islamic finance complete with market consultation and method of articulating these opinions and therefore paving the way to new ideas; the development of legal frameworks which are sustainable and based on internationally recognized standards and practices; and the potential role of sukuk in facilitating liquidity management, the strategy, for instance, on which the International Islamic Liquidity Management Corporation (IILM) has embarked upon.
Securitization, says Al-Amine, is expected to play a positive role in the future development of the sukuk market and seems to be the best way for the future of sukuk structuring because of the securitization condition of 'true sale' and legal transfer of ownership rather than just beneficial ownership. "These conditions shifts the risk of sukuk from the originator of the sukuk to the underlying asset. These principles ware more in line with Shariah principles than those followed so far in unsecured sukuk where the risk of the sukuk is fundamentally based on the creditworthiness of the originator," he maintains.
The author could have been more critical of the approach of the international rating agencies in rating not only sukuk but also Islamic finance products and institutions per se. They have stubbornly refused to design separate rating criteria to accommodate the specificities of Islamic finance in contrast to the Malaysian rating agencies RAM Rating Services and Malaysia Rating Corporation (MARC), which between them rate the largest number of sukuk issuance sin the world.
This book I believe is a valuable contribution to the literature on sukuk and Islamic finance, especially for regulators, market players, advisories, researchers, academics and students alike, although the author should be a little bit more discerning in some of his choices of references, especially media articles and reports by some institutions. (ArabNews/23-Dec-2011)

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